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 ^art, §>cr)affner & iftarp 
 fljr^e €conomic ©ssapa 
 
 THE CAUSE AND EXTENT OF THE RECENT INDUS- 
 TRIAL PROGRESS OF GERMANY. By Earl D. Howard. 
 
 THE CAUSES OF THE PANIC OF 1893. By William J. 
 Lauck. 
 
 INDUSTRIAL EDUCATION. By Harlow Stafford Person, 
 Ph.D. 
 
 FEDERAL REGULATION OF RAILWAY RATES. By Al- 
 bert N. Merritt, Ph.D. 
 
 SHIP SUBSIDIES. An Economic Study of the Policy of Sub- 
 sidizing Merchant Marines. By Walter T. Dunmore. 
 
 SOCIALISM: A CRITICAL ANALYSIS. By O. D. Skelton. | 
 
 INDUSTRIAL ACCIDENTS AND THEIR COMPENSATION. 
 By Gilbert L. Campbell, B. S. 
 
 THE STANDARD OF LIVING AMONG THE INDUSTRIAL 
 PEOPLE OF AMERICA. By Frank H. Streightoff. 
 
 THE NAVIGABLE RHINE. By Edwin J. Clapp. 
 
 HISTORY AND ORGANIZATION OF CRIMINAL STATIS- 
 TICS IN THE UNITED STATES. By Louis Newton 
 Robinson. 
 
 SOCIAL VALUE. By B. M. Anderson, Jr. 
 
 FREIGHT CLASSIFICATION. By J. F. Strombeck. 
 
 WATERWAYS VERSUS RAILWAYS. By Harold Glenn 
 Moulton. 
 
 THE VALUE OF ORGANIZED SPECULATION. By Harri- 
 son H. Brace. 
 
 INDUSTRIAL EDUCATION: ITS PROBLEMS, METHODS 
 AND DANGERS. By Albert H. Leake. 
 
 THE UNITED STATES INTERNAL TAX HISTORY FROM 
 I 86 1 TO I 87 I . By Harry Edwin Smith. 
 
 WELFARE AS AN ECONOMIC QUANTITY. By G. P. Wat- 
 kins. 
 
 CONCILIATION AND ARBITRATION IN THE COAL IN- 
 DUSTRY IN THE UNITED STATES. By Arthur E. Suf- 
 fern. 
 
 THE CANADIAN IRON AND STEEL INDUSTRY. By W. J. 
 A. Donald. 
 
 THE TIN PLATE INDUSTRY. By D. E. Dunbar. 
 
 THE MEANS AND METHODS OF AGRICULTURAL EDU- 
 CATION. By Albert H. Leake. 
 
 THE TAXATION OF LAND VALUE. By Yetta Scheftel. 
 
 RAILROAD VALUATION. By Homer Bews Vanderblue. 
 
 RAILWAY RATES AND THE CANADIAN RAILWAY COM- 
 MISSION. By D. A. MacGibbon. 
 
 THE CHICAGO PRODUCE MARKET. By Edwin Griswold 
 Nourse. 
 
 THE ARBITRAL DETERMINATION OF RAILWAY WAGES. 
 By J. Noble Stockett. 
 
 THE RESULTS OF MUNICIPAL ELECTRIC LIGHTING 
 IN MASSACHUSETTS. By Ldmond Earle Lincoln. 
 
 FAIR VALUE. The Meaning and Application of the Term 
 "Fair Valuation" as used by Utility Commissions. By 
 Harleigh H. Hartman. 
 
 A HISTORY OF THE ATLANTIC COAST LINE RAIL- 
 ROAD. By Harold Douglas Dozier.
 
 %<xd> (itfaflMt & (Wat* $xty <&88ty8 
 
 xxvin 
 
 FAIR VALUE 
 
 THE MEANING AND APPLICATION OF THE TERM 
 
 "FAIR VALUATION " AS USED BY t 
 
 UTILITY COMMISSIONS
 
 FAIR VALUE 
 
 THE MEANING AND APPLICATION OF 
 
 THE TERM "FAIR VALUATION" AS USED 
 
 BY UTILITY COMMISSIONS 
 
 BY 
 
 HARLEIGH H. HARTMAN, MA., LL.M. 
 
 LECTURER IN ILLINOIS PUBLIC UTILITIES LAW AT NORTHWESTERN 
 
 UNIVERSITY SCHOOL OF LAW, SOMETIME INSTRUCTOR 
 
 IN ECONOMICS AT LAKE FOREST COLLEGE 
 
 BOSTON AND NEW YORK 
 HOUGHTON MIFFLIN COMPANY 
 
 (£be fiitocrsiiDc prcjffa <gambrtDge 
 
 1920
 
 COPYRIGHT, I92O, BY HART, SCHAFFNER & MARX 
 ALL RIO UTS RESERVED
 
 
 TO 
 JOHN H. WIGMORE 
 
 DEAN OF NORTHWESTERN UNIVERSITY SCHOOL OF LAW
 
 PREFACE 
 
 This series of books owes its existence to the generosity of 
 Messrs. Hart, Schaffner & Marx, of Chicago, who have 
 shown a special interest in trying to draw the attention of 
 American youth to the study of economic and commercial 
 subjects. For this purpose they have delegated to the under- 
 signed committee the task of selecting or approving of 
 topics, making announcements, and awarding prizes an- 
 nually for those who wish to compete. 
 
 For the year ending June 1, 1918, there were offered: 
 
 In Class A, which included any American without re- 
 striction, a first prize of $1000, and a second prize of $500. 
 
 In Class B, which included any who were at the time 
 undergraduates of an American college, a first prize of $300, 
 and a second prize of $200. 
 
 Any essay submitted in Class B, if deemed of sufficient 
 merit, could receive a prize in Class A. 
 
 The present volume, submitted in Class A, was awarded 
 
 first prize in that class. 
 
 J. Laurence Laughlin, Chairman 
 University of Chicago 
 
 J. B. Clark 
 
 Columbia University 
 
 Henry C. Adams 
 
 University of Michigan 
 
 Edwin F. Gay 
 
 N. Y. Evening Post 
 Theodore E. Burton 
 
 New York City
 
 NOTE 
 
 The author gratefully acknowledges his indebtedness to 
 Professor J. M. Clark, of the University of Chicago, for 
 kind assistance, careful criticism, and helpful suggestions 
 given in the final preparation of this thesis. Much credit is 
 also due the author's wife for her constant encouragement 
 and cooperation. For all matters of opinion, however, and 
 for the manner of presentation the author assumes com- 
 plete responsibility. 
 
 Harleigh H. Hartman 
 
 Springfield, III. 
 April, 1919
 
 AUTHOR'S PREFACE 
 
 The term "fair value" is a scapegoat of the cost theory 
 coined by the courts and adopted by public-utility com- 
 missions. The scope of the term is broad, its usage loose. 
 It has been employed in many phases of regulation includ- 
 ing rate-making, purchase and sale, security issue, reorgan- 
 ization, tax and government-ownership cases. The "fair 
 value" of the property has varied for each of these pur- 
 poses. The result has been confusion, misunderstanding, 
 and misuse of the term and much superficial wrangling. 
 There is no real agreement concerning the most funda- 
 mental principles of valuation. There is confusion as to 
 terminology, methods, even as to the objects sought. 
 
 The causes of this chaos are easily discernible. Two par- 
 ties, the public and the utilities, are vitally concerned. 
 Both are convinced that their interests are inherently 
 antagonistic. The courts stand arbitrator between them. 
 New issues are presented at a time when the whole political, 
 economic, and legal concept of the relation of government 
 to industry and private property is in a transitional state. 
 The issue has augmented the existing conflict between judi- 
 cial and legislative functions resulting from new applica- 
 tions of the due-process clause. The sphere of judicial activ- 
 ity at the start of the valuation problem was itself unsettled. 
 No precedents exist to guide the court in its arbitration. 
 Blind groping has resulted. The parties have been unwill- 
 ing to study the situation more than superficially. The 
 utilities and over-zealous public representatives have 
 framed their words and acts to create opportunities for 
 self-gain, irrespective of the ultimate effects of their poli- 
 cies. The courts seem to have followed the course of least 
 resistance. 
 
 Credit for such progress as has been made is due to
 
 sdi AUTHOR'S PREFACE 
 
 the State Public-Utility Commissions. Their efforts, how- 
 ever, have been handicapped by the necessity of trying to 
 prophesy, and shape their opinions to meet, the undefined 
 course of judicial review which persistently refuses to state 
 either the basis upon which it rests or the aims it seeks. 
 
 There is little reason to expect either the utilities or 
 public representatives to forget self-interest, voluntarily 
 analyze the problem, and submit an unbiased compromise. 
 The commissions are powerless wholly to clear the confu- 
 sion superimposed upon the situation by judicial review. 
 The courts can clear the tangle, but before this is possible 
 they themselves must glean a much clearer understanding 
 of the theory of " fair value " than they have thus far incor- 
 porated in their decisions. They must accept the task of 
 determining the basis and aims of regulation, and definitely, 
 unambiguously state them. 
 
 The study of valuation, in the meantime, must be essen- 
 tially theoretical. It cannot be worked out from existing 
 decisions alone since they themselves are to be tested by it. 
 Neither can it be worked out independently of them and 
 test them. A twofold division of the subject is suggested, 
 i.e., the theory of " fair value " and the application of the 
 theory to the existing situation. This division has been 
 adopted by the author. 
 
 The first part of the treatise considers (1) the problem 
 of public-utility regulation and the characteristics which 
 distinguish it from that of regulation in general; (2) the 
 specific needs it suggests, and the essential elements in a 
 regulatory system which will meet those needs; (3) the 
 development of the valuation theory; (4) valuation as an 
 element in regulation, its compatibility with existing legal 
 concepts, its advantages and dangerous characteristics; 
 (5) " fair value," the type of valuation best suited to public- 
 service regulation and to existing legal rules. 
 
 The second part of the thesis applies the general princi- 
 ples formulated in the first part to the actual practice in
 
 AUTHOR'S PREFACE xiii 
 
 commission-valuation cases. To render the results of this 
 study more readily accessible, this part of the subject has 
 been divided in the manner common to prior works on 
 valuation. The leading valuation cases of the several com- 
 missions are analyzed, and the rules applied in the principal 
 jurisdictions formulated. These rules are subject to test as 
 to their economic soundness and their conformity to legal 
 requirements. Where a discrepancy appears between com- 
 mission rule and economic law or legal requirement, it is 
 carefully considered and the author's conception of the 
 expedient means of removing the discord stated. 
 
 The thesis attempts to state the theory of fair value, the 
 law, and the practice.
 
 CONTENTS 
 PART I 
 
 THE MEANING OF THE TERM " FAIR VALUE " 
 
 CHAPTER I 
 
 The Basis of Regulation 
 
 I. Introductory Statement 3 
 
 II. Private Property 3 
 
 III. Limitations upon the Use of Private Prop- 
 
 erty 5 
 
 IV. The Laissez-Faire Doctrine 6 
 V. Price Economics 7 
 
 VI. The Granger Reaction 8 
 VII. Munn v. Illinois 9 
 VIII. Monopoly as a Basis for Regulation 11 
 IX. The Public-Interest Theory 15 
 X. Judicial Recognition of the Public In- 
 terest, 20 
 XI. Summary 25 
 
 CHAPTER n 
 
 The Purpose of Regulation 
 
 I. Regulation and Private Interest 27 
 
 II. Service Requirements 28 
 
 III. Rate Regulation 29 
 
 IV. The Social Side of Regulation 29 
 V. Northern Pacific Railway v. North 
 
 Dakota 31 
 
 VI. Anti-Monopoly Regulation 33 
 
 VII. The Recognition of Regulated Monopoly 34
 
 xvi CONTENTS 
 
 VIII. The Reasons fob the Change 36 
 
 IX. Speculation 39 
 
 X. Efficient Management 41 
 
 XI. Financial Regulation 42 
 
 XII. Accounting 43 
 
 XIII. Summary 44 
 
 CHAPTER HI 
 
 Valuation and Regulation 
 
 I. Valuation a Judicial Theory 45 
 
 II. The Granger Cases 45 
 
 III. The Commission Cases 48 
 
 IV. Dow v. Beidelman 51 
 V. Reagan v. The Farmers' Loan and Trust 
 
 Company 55 
 VI. The Growth of the Confiscation Analogy 57 
 VII. Smyth v. Ames 59 
 VLIL The Condemnation Theory 63 
 IX. San Diego Land and Town Company v. Na- 
 tional City 71 
 X. Valuation as a Test for Individual Rates 73 
 XL The Recent Decisions 73 
 XII. Summary 74 
 
 CHAPTER IV 
 
 The Theory of Valuation 
 
 I. Valuation and Economics 77 
 
 II. The Meaning of Value 77 
 
 III. The Varying Uses of Valuation 79 
 
 IV. Fair Value not Exchange Value 80 
 V. Valuation for Rate-Making 81 
 
 VI. Valuation for Purchase and Sale 88 
 
 VII. The Methods of Valuation 90 
 
 VIII. Summary 92
 
 CONTENTS xvii 
 
 CHAPTER V 
 
 Valuation Methods 
 
 I. The Inventory 94 
 
 II. The Original-Cost Theory 97 
 
 III. The Reproduction-Cost Theory 99 
 
 IV. Development of the Reproduction Theory 100 
 V. The Purpose of the Reproduction-Cost 
 
 Appraisal 105 
 
 VI. Attempt to Discredit Original Cost 107 
 
 VII. Defects of Strained Reproduction Cost 112 
 
 VIII. The Actual-Investment Theory 113 
 
 IX. The Supreme Court and Reproduction Cost 119 
 
 X. Summary 124 
 
 PART II 
 
 THE APPLICATION OF THE THEORY OF FAIR VALUE 
 
 CHAPTER VI 
 
 The Valuation of Tangible Property 
 
 I. Tangible and Intangible Values 129 
 
 II. Property not Used or Useful 129 
 
 III. Property acquired without Cost 133 
 
 IV. Property acquired from Surplus 134 
 V. The Valuation of Land 138 
 
 VI. The Original-Cost Appraisal 140 
 
 VII. Appreciation of Land Values 141 
 
 VEIL The Reproduction-Cost Appraisal 146 
 
 IX. Valuation of Buildings 151 
 
 X. Water Rights 153 
 
 XL Pavement over Mains 157 
 
 XII. Summary 159
 
 xviii CONTENTS 
 
 CHAPTER VII 
 
 Valuation of Intangible Property 
 
 I. Overhead Charges 161 
 
 II. Organization Expenses 166 
 
 III. Promoters' Profits 167 
 
 IV. Interest during Construction 167 
 V. Engineering and Superintendence 170 
 
 VI. Contractors' Profits 172 
 
 VII. Discount on Bonds 173 
 
 VIII. Piecemeal Construction 175 
 
 IX. Adaptation and Solidification 176 
 
 X. Going Value 177 
 
 XI. Going-Concern Value 180 
 
 XII. Going Value and Exchange Differential 181 
 
 XIII. "Good- Will" 182 
 
 XIV. The Wisconsin Rule 184 
 XV. The Comparative-Plant Estimate of Go- 
 ing Value 186 
 
 XVI. Going Value and the Courts 188 
 
 XVII. Franchise Value 190 
 
 XVIII. Working Capital 193 
 
 \ XIX. Summary 194 
 
 CHAPTER VIII 
 
 Depreciation 
 
 I. The Theory of Depreciation 196 
 
 II. Efficiency and Depreciation 198 
 
 III. Judicial Holdings on Depreciation 202 
 
 IV. Salvage Value 204 
 V. Depreciation of Intangibles 205 
 
 VI. Estimated Life 206 
 
 VII. The Maintenance Plan and Appraisal 207 
 
 VIII. The Straight-Line Method 207 
 
 IX. The Diminishing-Balance Method 209
 
 CONTENTS 
 
 xix 
 
 X. The Annuity Method 210 
 
 XI. The Sinking-Fund Method 211 
 
 XII. Miscellaneous Methods 212 
 
 XIII. The Colorado Theory of Depreciation 213 
 
 XIV. The Depreciation Reserve 216 
 XV. Summary 218 
 
 CHAPTER IX 
 
 The Return on the Investment 
 
 I. Valuation and the Rate of Return 220 
 II. The Development of the Return Ques- 
 tion 221 
 
 III. Elements Involved in the Return 222 
 
 IV. The Interest Element in the Return 224 
 V. The Risk Element in the Return 225 
 
 VI. The Rate of Return 227 
 
 VII. Duplication in Valuation and Return 229 
 
 VIII. Reward for Efficient Management 229 
 
 IX. Allowance for Surplus 231 
 
 X. Summary 231 
 
 CHAPTER X 
 
 Conclusion 233 
 
 Selected Bibliography 237 
 
 Table of Cases 241 
 
 Index 253
 
 FAIR VALUE 
 
 PART I 
 THE MEANING OF THE TERM "FAIR VALUE"
 
 FAIR VALUE 
 
 CHAPTER I 
 
 ' THE BASIS OF REGULATION 
 
 I. Introductory Statement 
 
 The primary question in regulation is the legal and eco- 
 nomic status of private property. To discuss valuation 
 without considering the nature of public-utility property, 
 the reasons for its control, and the aims of regulation would 
 be to argue the expediency of means without knowing the 
 ends sought. This fallacy has characterized most discus- 
 sion of valuation. There has been no attempt to decide fun- 
 damental issues. It seems advisable, therefore, even at the 
 risk of criticism for using primer methods and covering 
 ground already trodden, to begin with a consideration of 
 the status of "private property devoted to a public use." 
 
 II. Private Property 
 
 The term "private property" is a misnomer. There is no 
 strictly private interest in property enjoyed to the com- 
 plete exclusion of all other interests. This point cannot be 
 too strongly emphasized, for therein lies the basis of all 
 regulation affecting property rights. 
 
 Property has been defined as "the right and interest 
 which a man has in lands and chattels to the exclusion of 
 others." The word "right" is used collectively. Man has 
 many rights relative to the object he is said to own, which 
 combined constitute his property in the object; i.e., the 
 right of possession, the restricted rights of consumption, 
 use, and disposal by sale, gift, loan, or rental. Property is 
 a bundle of rights, the units of which are constantly chang- 
 ing with economic changes and their legal recognition.
 
 4 FAIR VALUE 
 
 Property as distinct from possession implies exclusive 
 control. Such control can exist only by consent of the State. 
 The sanction of society and force of government are neces- 
 sary to protect the owner's interest. The presence of an or- 
 ganized social state is essential to the existence of private 
 property. It is purely a social concept, and the rights con- 
 stituting property at any given time depend upon social 
 arrangements sanctioned by the State with a view to the 
 general welfare. 
 
 Private property, irrespective of the theory of its origin, 
 is shaped by two conflicting forces giving it both a social 
 and an individual side. Individuals are permitted to acquire 
 rights protected by the State, because such permission pro- 
 motes the public welfare. The private interest, however, is 
 held in subordination by the State police power, in order 
 that the exclusive control thus created may in reality pro- 
 mote the common good. The social interest on which the 
 whole structure rests limits the owner in his use of the prop- 
 erty. All property is acquired and held under the limitation 
 of the common-law maxim, " Sic utere tuo ut alienum nort 
 Icedas," that it shall not be used in a way injurious to the 
 rights of others nor to impair the public rights. The State 
 does not create unrestricted private property rights in ob- 
 jects which affect or influence the public welfare. The pub- 
 lic interest in such property must be protected or the excuse 
 for government sanction of the private interest destroyed. 
 The so-called absolute property rights are but privileges 
 relative to, and limited by, the common good. The individ- 
 ual and the public interest, though independent, attach to 
 the same object and blend. The individual is so related to 
 society that his interest is one with that of the group. The 
 social interest is as necessary to private property as the in- 
 dividual interest, and individual rights can be protected 
 only by development of the public interest. The individual 
 right is a right to use private property in the interest of the 
 community. Regulation compels such use of the property.
 
 THE BASIS OF REGULATION 5 
 
 The two forces moulding private property, because one 
 limits the other, are antagonistic. The elements which make 
 the social side essential necessitate the domination of the 
 social over the individual element in the conflicts which re- 
 sult. The tendency, therefore, is toward an ever greater 
 public element in private property. Each new conflict ulti- 
 mately results in additional gain for the social side of the 
 property. Regulation based on valuation is such a conflict. 
 
 III. Limitations upon the Use of Private Property 
 
 All private property is held conditionally. The owner 
 must so use it as not to injure others. It is apparent that the 
 danger of, and opportunity for, such injury must vary both 
 in form and degree with the use to which the property is 
 put. The State in seeking to protect the public interest 
 must impose different forms of regulation upon the differ- 
 ent uses of the property. The bundle of rights constituting 
 property changes with the use, becoming more or less en- 
 cumbered, acquiring or losing unit rights as the use pro- 
 motes or endangers the public welfare. Property used in 
 connection with slaughter-houses, pest-houses, and manu- 
 facture of explosives is subjected to stringent regulation to 
 promote the public health. The same property used for sa- 
 loon or questionable lodging-house purposes would be sub- 
 jected to other forms of regulation with a view to promo- 
 tion of the public morals. This property used for strictly 
 residence purposes would meet with but little governmen- 
 tal interference. Devoted to a public use and employed in 
 the conduct of a public-service business, the property is 
 subjected to regulation drafted primarily to promote the 
 economic welfare of the public. 
 
 Public-service corporations have always been classified 
 separately in American law. Private property employed in 
 the public service has always been subject to restrictions in 
 the interest of the public. The social side of the property 
 has always been more prominent than the strictly private
 
 6 ' FAIR VALUE 
 
 interests. The emphasis on the public interest in such prop- 
 erty and the accompanying distinction between utilities 
 and other industry is based on the common law and ante- 
 dates the establishment of the colonies. 
 
 IV. The Laissez-Faire Doctrine 
 
 The regulation and restriction imposed by the Govern- 
 ment on private property devoted to a public use in addi- 
 tion to that imposed on all private property, and conse- 
 quently the bundle of rights composing private property 
 in such a use, undergo constant change. The political, 
 social, and economic order is slowly but continually shift- 
 ing. The private rights and the public interest increase 
 or decrease to meet economic and social conditions. From 
 the middle of the eighteenth century to 1870 private in- 
 terests predominated. Economic conditions in America 
 throughout the colonial period and the early days of the 
 Republic did not justify emphasis on. the difference be- 
 tween property employed in the public service and that de- 
 voted to a strictly private use. The differentiation and the 
 corollary power of regulation, therefore, remained dor- 
 mant, and a strict laissez-faire policy was adopted. 
 
 A vast, thinly populated territory lay open to develop- 
 ment. Governments were new and overburdened. Heavy 
 taxes could not be collected. Innumerable local improve- 
 ments were needed. The very vastness of the land, which 
 rendered transport and communication facilities necessary, 
 made them more difficult to secure. Private capital was the 
 only means available for the work. Every effort was made 
 to encourage its investment in enterprises which would 
 develop the land. 
 
 The territory to be served was too broad, the capital re- 
 quired too great, the demand for other improvements too 
 pressing to justify viewing the encroachment of individual 
 initiative with feeling other than relief. The situation was 
 not complex. The corporation was in its infancy. The terri-
 
 THE BASIS OF REGULATION 7 
 
 tory served by, and the capital invested in, each utility was 
 small. Competition between utilities and with substitute 
 service was abundant, and the prevailing public opinion re- 
 garded competition as a panacea for all industrial ills. There 
 was little to fear, much to be gained, from stimulation of 
 private enterprise. 
 
 The legislatures responded to the demands of the time by 
 giving private enterprise an entirely free hand, and ex- 
 tending active aid to those who could be induced to under- 
 take the work. The power of eminent domain was granted 
 and liberally construed. Public lands were freely given. 
 Public funds were invested in the securities of the compa- 
 nies or given to the promoters outright. Charters and fran- 
 chises were lavishly bestowed and prodigally drafted. Every 
 effort was put forth to make the undertaking an invit- 
 ing speculation. The public nature of the enterprises was 
 widely advertised, and persons investing in them were her- 
 alded as public benefactors. 
 
 The policy was not restricted to public-service companies. 
 All industry flourished under the laissez-faire system. Indi- 
 vidualism was supreme. Private interests were emphasized, 
 and private property enjoyed a legal status theretofore and 
 since unknown. 
 
 V. Price Economics 
 
 The result of the laissez-faire policy was a reorganiza- 
 tion of economic theory upon an emphasized private-prop- 
 erty basis. Pursuit of individual gain and production for 
 exchange became the dominant factors in industry. An 
 exchange economics was worked out, centering on price, 
 the medium of exchange. Price became the all important 
 factor in industry. The theory of price underlies all eco- 
 nomic theory of the period. 
 
 The economic system which emphasized individual gain 
 and exchange price was bound to produce undesirable re- 
 sults when applied to the public service. The public interest
 
 8 FAIR VALUE 
 
 in the undertaking received no consideration in such an 
 economic system. The social side of private property was 
 subordinated to the individual side and lost sight of. The 
 public interest in the service was secondary to private 
 gain. Reasonable rates were replaced by market price. 
 The basis of private property, the excuse for its creation 
 and maintenance, was overlooked. 
 
 VI. The Granger Reaction 
 
 It was inevitable that application of price economics to 
 the public service, the mania for development and the ac- 
 companying opportunities for enrichment of private, at the 
 expense of public, interests afforded by the laissez-faire 
 policy should produce wholesale evils. Shippers demanded 
 and received rebates. Discriminations were granted and 
 accepted. Utility operators, promoters, investors, and con- 
 sumers vied to squeeze the opportunity dry. 
 
 It was equally inevitable that the abuses of the period 
 should produce a reaction. Changed economic conditions, 
 the growth of the factory system, the congestion of popula- 
 tion in urban districts, and the increase of wealth rendered 
 a continuation of the laissez-faire policy dangerous. Strin- 
 gent legislation became necessary to make property rights 
 serve the purpose for which they were created, the promo- 
 tion of the public welfare; to offset the undue emphasis of 
 the private side of property by the laissez-faire policy; and 
 to substitute an economics based on public interests and 
 reasonable charges rather than private gain and prices 
 fixed by individualistic enterprise and free bargain. 
 
 The revolt started in the West as a clamor for a renewal 
 of governmental control, a reassertion of the public interest, 
 and a reaffirmation of the purpose of property rights. The 
 acute need of development and the absolute dependence 
 upon the utilities for connection with markets and in- 
 dustrial centers, had made that section the harvest field of 
 unscrupulous promoters and had forced utility problems to
 
 THE BASIS OF REGULATION 9 
 
 the front. The five years preceding 1870 produced a com- 
 plete change in public opinion. Indignation was aroused. 
 The Patrons of Husbandry, or Grange, served as a medium 
 to spread the discontent; and it rapidly developed, under 
 railway defiance of public interests, into rabid prejudice. 
 
 The rate issue was the most vital. The laissez-faire policy 
 had resulted in the establishment of monopoly prices 
 at all non-competitive points and discriminatory charges 
 based on a competitive exchange price elsewhere. Reason- 
 able rates were unknown. To correct the situation a wave of 
 maximum-rate legislation swept the Middle West. The util- 
 ities, championed by the railways, contested the constitu- 
 tionality of the laws. The issue was the sacredness of the 
 private-property interests which the laissez-faire policy had 
 emphasized without due regard to the purpose of property 
 rights. The question was carried to the Federal Supreme 
 Court and the State's right to regulate, to confine property 
 rights to their proper sphere, was upheld in the Granger 
 Cases. 1 A movement was thus inaugurated which has rev- 
 olutionized the relation of government to industry. 
 
 VII. Munn v. Illinois 
 
 In Munn v. Illinois, 2 the principal Granger Case, the 
 latent power of regulation was revivified. The public utility 
 was again singled out from other industries and subjected 
 to regulation. The case came before the Court on the ques- 
 tion of the constitutionality of an Illinois law fixing the 
 charges for warehouses. The prime problem was to justify 
 the segregation of warehouses from other industries for 
 
 1 There were eight Granger cases arising from the maximum rate laws 
 of the Mid- Western States. All save the Munn Case involved railway regu- 
 lation. They were: Munn v. Illinois, 94 U.S. 113, 24 L. ed. 72; Chicago, Bur- 
 lington & Quincy R.R.Co. v. Iowa, 94 U.S.155, 24 L. ed. 94; Peik v. Chicago 
 & Northwestern Ry. Co., 94 U.S. 164; Chicago, Milwaukee & St. Paul 
 Ry. Co. v. Ackley, 94 U.S. 179; Winona and St. Peter R.R. Co. v. Blake, 
 94 U.S. 180, 45 L. ed. 99; Southern Minnesota R.R. Co. v. Coleman, 94 U.S. 
 181; Stone v. Wisconsin, 94 U.S. 181, 24 L. ed. 102. 
 
 8 94 U.S. 115, 24 L. ed. 72.
 
 10 FAIR VALUE 
 
 regulatory purposes. The propriety of applying the laissez- 
 faire policy to other industry was not questioned. The fact 
 that the sanctity of the emphasized private rights in prop- 
 erty in general was still unchallenged rendered the prob- 
 lem difficult. The way, however, had been paved for the 
 decision by the Supreme Court's holding in the case of 
 Olcott v. The Supervisors, 1 that irrespective of the private 
 ownership of the property a railroad is a public highway 
 performing a governmental function for which it is paid by 
 being granted the right to exact reasonable tolls. 
 
 The Munn decision accepts the theory of the Olcott 
 Case. 2 The private property of the utility operator is em- 
 
 1 16 Wall. 695; 83 U.S. 678. "It has never been considered a matter of 
 any importance that the road was built by the agency of a private corpora- 
 tion. No matter who is the agent, the function performed is that of the State. 
 Though the ownership is private, the use is public. . . . That railroads, 
 though conducted by private corporations and owned by them, are public 
 highways has been the doctrine of nearly all the courts ever since such con- 
 veniences for passage and transportation have had any existence. . . . And 
 the reason why the use has always been held a public one is that such a 
 road is a highway, whether made by the Government itself or by the 
 agency of corporate bodies, or even by individuals when they obtain their 
 power to construct it from legislative grant. 
 
 "So turnpikes, bridges, ferries, and canals, although made by individu- 
 als under public grants, or by companies, are regarded as publici juris. 
 The right to exact tolls or charge freight is granted for a service to the 
 public. . . . 
 
 " They [highways] have always been governmental affairs and it has ever 
 been recognized as one of the most important duties of the State to provide and 
 care for them. ... It is said that railroads are not public highways per se: 
 That they are only declared such by the decisions of the courts, and that 
 they have been declared public only with respect to the power of eminent 
 domain. This is a mistake. In their very nature they are public highways. It 
 needed no decision of courts to make them such. True they must be used 
 in a peculiar manner, and under certain restrictions, but they are facilities 
 for passage and transportation afforded to the public, of which the public 
 has a right to avail itself. As well might it be said a turnpike is a highway, 
 only because declared such by judicial decision. A railroad built by the 
 State no one claims would be anything else than a public highway, justi- 
 fying taxation for its construction and maintenance, though it could be no 
 more open to public use than is a road built and owned by a corporation." 
 
 2 "Looking, then, to the common law, from whence came the right 
 which the Constitution protects, we find that when private property is
 
 THE BASIS OF REGULATION 11 
 
 ployed in a public business for the private purpose of mak- 
 ing individual gain. But because the business affects the wel- 
 fare of the whole community, the private interest in profits 
 is subordinated to the public interest. The property re- 
 mains private so far as title is concerned, but loses its sta- 
 tus as strictly private property. The bundle composing pri- 
 vate property is changed. Some of the unit rights are lost. 
 The bundle is decidedly smaller. An encumbrance is placed 
 upon the property as real as that created by dedication. It 
 must be used subject to governmental supervision, and 
 primarily to promote the public welfare by rendering con- 
 tinuous, adequate service without discrimination and at 
 reasonable rates. The charges, representing both rental or 
 interest and pay for conducting the enterprise, must be 
 such as will promote the public good. The property has been 
 shorn of the power it possessed, under the laissez-faire 
 theory, of producing all the profit unrestricted conditions 
 would afford. The promotion of the general economic wel- 
 fare which first created private property rights and then or- 
 dained that they be given free sway to provide incentive 
 for development, now demands that they be limited. Abso- 
 lute freedom has ceased to promote the common good. Reg- 
 ulation becomes necessary. 
 
 VIII. Monopoly as a Basis for Regulation 
 
 The reference to monopolistic power and citation of 
 
 Aldnut v. Inglis 2 in the Munn Case gave rise to an attempt 
 
 affected with a public interest it ceases to be juris privati only. . . . Pri- 
 vate property does become clothed with a public interest when used in a 
 manner to make it of public consequence, and affect the community at large. 
 When therefore one devotes his property to a use in which the public has 
 an interest, he, in effect, grants the public an interest, in that use, and must 
 submit to be controlled by the public for the common good, to the extent of 
 the interest he has thus created. He may withdraw his grant by discontin- 
 uing the use; but so long as he maintains the use, he must submit to the 
 control. . . . 
 
 "They [the warehouses] stand, to use the language of their counsel, in 
 the ' gateway of commerce, ' and take toll from all who pass. Their business 
 most certainly tends to a common charge, and is become a thing of com- 
 mon interest and use." 2 12 East. 527.
 
 12 FAIR VALUE 
 
 to base regulation upon the monopolistic tendency in the 
 public-service business. The public mind has been directed 
 from the public nature of the undertaking toward the monop- 
 olistic theory of regulation and the sanctity of private 
 property. 
 
 Reference to monopoly cannot, unaided, explain public- 
 utility regulation. Such an explanation is superficial and 
 goes only halfway into the question. It does not explain 
 why the State may regulate a monopolistic business. It 
 fails to show why utility regulation differs from that ap- 
 plied to banks, insurance companies, and other monopolis- 
 tic enterprises. It determines neither the basis nor the aims 
 of regulation. The monopolistic theory of regulation is a 
 survival of the laissez-faire economic system. It is a com- 
 promise not in accord with the present regulatory theory, 
 and does not meet the issue squarely. 
 
 Monopolistic power in any business has been recognized 
 as necessitating governmental regulation since the early 
 days of the common law. Monopoly was especially repug- 
 nant to the judicial and economic theories based upon com- 
 petition as a regulatory force. There was a latent, inherent 
 power of harm seen in monopoly. Its threat prices were 
 feared, and monopolistic practices were considered as 
 necessarily contrary to the public welfare. 
 
 It is doubtful, however, whether the common law sub- 
 jected an industry to rate regulation on the ground of mo- 
 nopoly alone. It is certain that it did not conceive of 
 limitation of profits as distinct from prices, nor of service, 
 financial, and general economic regulation as a corollary 
 to a monopolistic tendency. Monopolies were regulated, 
 but always upon a basis wholly distinct from that justify- 
 ing and directing public-service company control. 
 
 Monopoly may justify regulation. It may emphasize the 
 public nature of a utility business. But it, unaided, cannot 
 create a public calling from a private enterprise, or give rise 
 to the "public interest" of the Munn Case.
 
 THE BASIS OF REGULATION 13 
 
 A banking or insurance company may enjoy a complete 
 monopoly while a neighboring telephone company strug- 
 gles with a vigorous competitor, yet the telephone company 
 is a public utility and its monopolistic neighbors retain 
 their private status. A carrier may secure complete control 
 of the most remunerative local traffic by private contract 
 without engaging in a public-service undertaking. The 
 completeness of his control over the industry may even 
 force out of business competitors who had undertaken the 
 public service without altering the private character of his 
 business. 
 
 Reference to monopoly is equally ineffective in explaining 
 the aims of regulation. An order prohibiting the invasion of 
 occupied territory or permitting a consolidation or merger 
 cannot be characterized as a eulogy of competition or an 
 elegy for monopoly. In rate-making the aim is the true nor- 
 mal price, which because of the waste of competition is in- 
 variably below the competitive figure. The whole stress of 
 regulation is to enforce charges not to the competitive 
 point, i.e., cost in the most disadvantageously located and 
 unskillfully operated plant that can survive during any 
 prolonged period, but beyond that point to the plane of the 
 most advantageously located and skillfully managed plant 
 that the locality is capable of supporting. Regulation, in 
 the case of public utilities, is more than a substitution for 
 competition. It must enforce the economies in production 
 that competition has never been powerful enough to com- 
 pel. It must avoid the waste of duplication and it must 
 eliminate the uncertainty and speculation of competitive 
 production. It substitutes the knowledge and judgment of 
 the Government for that of a competitor potential or real. 
 Its aim is promotion of the public good rather than promo- 
 tion of the interest of an individual competitor. It is moved 
 by forces which never come into play in a strictly competi- 
 tive industrial organization. 
 
 Monopoly, for the most part, plays the same role in the
 
 14 FAIR VALUE 
 
 public-service field that it does elsewhere in industry. Its 
 economic advantages are recognized, its evil forces held in 
 check. Because utilities are by nature best operated as mo- 
 nopolies, that form of organization is sanctioned for them. 
 Where regulated monopoly fails to provide adequate serv- 
 ice at reasonable rates, however, competition is called upon 
 for aid. 1 
 
 The different part which monopoly plays in the utility 
 and industrial field is rather a difference in the aims than in 
 the basis of regulation. Because the service is governmental, 
 because its public character 2 emphazises the undesirability 
 of duplication, the aim of utility regulation is to encourage 
 monopoly. In the general industrial field where the public 
 interest is not so intense, where the uncertainties of com- 
 petitive production are less disastrous, the aim of regulation 
 is to encourage large-scale production but upon a competi- 
 tive, not a monopolistic, basis. Competition is not harmful 
 to the public welfare and is made a part of the regulatory 
 system just as it is in utility control when other regulation 
 fails because a company is unwilling or unable to render 
 adequate service. The point is that the public welfare de- 
 mands a different form of regulation in the case of utilities 
 not because competition is impossible, but because it is un- 
 desirable. More rigid regulation is necessary in the public 
 service than elsewhere, not because monopoly is more dan- 
 gerous or more apt to be present, but because the undertak- 
 
 1 Re Coles Co. Tel. & Telg. Co., 111. Pub. Utilities Comm. No. 7280, 
 7313; Re Northampton Co., Water Co. (Pa.) P.U.R. 1917-E-939; Re 
 Cayuga Power Corp. (N.Y.) P.U.R. 1917-E-915; Re Poy Sippi Tel. Co. 
 (Wis.)P.U.R. 1917-B-469; Vogt v. Linden Tel. Co. (Wis.) P.U.R. 1917-A- 
 614; Allegheny Valley St. R.R. Co. v. Greco (Pa.) P.U.R. 1917-A-723, etc. 
 
 * "Natural monopoly" when analyzed seldom means real inability to 
 duplicate service. It means simply that the common weal will be better 
 served by a single system than by duplication. The public welfare is the 
 basis of the idea of natural monopoly. Few utilities are strictly monopolis- 
 tic in the sense that duplication or competitive substitute service is really 
 impossible. Though duplication would involve a real disadvantage, the 
 advantages of location are scarcely more pronounced in the utility field 
 than elsewhere.
 
 THE BASIS OF REGULATION 15 
 
 ing is governmental, because the service must be guaran- 
 teed, and centralized control is advantageous. There is a 
 socialistic element present that does not exist in the regula- 
 tion of other industries. 1 The industry regulated cannot be 
 left to the uncertainties of competition. Utility commis- 
 sions have repeatedly found themselves compelled to deny 
 the voluntary petitions of utility companies for permission 
 to discontinue service. Adequate, continuous, efficient 
 service must be enforced at a price low enough to insure 
 its general use. The public has an interest not only in the 
 service, but in the profit, which is not created by monopoly. 
 
 IX. The Public-Interest Theory 
 
 The attempt to base the decision in Munn v. Illinois pri- 
 marily upon the monopoly theory is superficial, misleading, 
 and unjustifiable. That case and its cited authority, if one 
 will pause to go below the language of the opinions, clearly 
 premises the regulation of public-service companies on the 
 public nature of the business which, because the welfare of 
 the community at large is at stake and the State is forced 
 practically to guarantee the service, both as to quality and 
 price, assumes the character of a governmental function. 2 
 
 1 The recent abnormal cost of producing public-utility service has em- 
 phasized this phase of the question. The practical impossibility of compel- 
 ling prolonged service by a private company at less than cost forced Mas- 
 sachusetts to revert to subsidies and spread the cost of street-railway 
 service by general taxation in an effort to maintain adequate service and 
 keep rates at a point which would permit universal use of the service. 
 Regulation considered the general need and the governmental character 
 of the service not monopoly prices. 
 
 2 The courts have repeatedly pointed out the governmental character 
 of the service rendered. " A railroad once constructed is instanter, and by mere 
 force of the grant and law, embodied in the governmental agencies of the State 
 and dedicated to the public use, all and singular its cars, engines, right of 
 way and property of every description, real, personal, and mixed, are but a 
 trust fund for the political power. The corporation created by sovereign 
 power expressly for this sole purpose and no other, is in the most strict, 
 technical, and unqualified sense, but its trustee. This is the primary and 
 sole motive for its creation. The incidental interest and profit of individu- 
 als are accidents both in theory and in practice." Talcott v. Pine Grove,
 
 16 FAIR VALUE 
 
 The construction and maintenance of transportation agen- 
 cies and the provision of adequate water and lighting sys- 
 tems is a public duty. The power of the State to conduct the 
 service is unquestioned. When the State waives its right to 
 serve and an individual assumes the duty, he volunteers to 
 do the work of the State. The basis of regulation is to be 
 found in the governmental nature of the service. 
 
 The service, because it is a common necessity and the 
 supply is so limited as to be capable of control by a few per- 
 sons, becomes a right of the public subject only to certain 
 general conditions applicable to all alike. Control of that 
 right is "farmed out," by way of franchise privileges, to 
 individuals. The Government waives its right to conduct 
 the undertaking, but cannot waive its responsibility for 
 the service rendered. The social side of the private property 
 devoted to the public use necessarily becomes dominant. 
 The Munn Case and subsequent decisions recognize this 
 fact. The monopoly element is introduced into the decisions 
 
 1 Flipp. (U.S.) 120; "A railroad corporation is created for public purposes 
 and -performs a function of the State, and is under governmental supervi- 
 sion and control," Culver v. St. Joseph & G. I. Ry. Co. (Mo.) P.U.R. 1917- 
 B-542, 554; "The duties, functions, and property of railroad corporations 
 are held in trust by the corporation for the public, and the sovereign power 
 regulates such corporations as its trustee," People v. N. Y. C. & H. R.R. 28 
 Hun (N.Y.) 543; see also Smalley, Railroad Rate Control, pp. 13-21; 
 " The creation of all highways is a public duty. Railroads are highways. 
 The State may build them. If an individual does the work he is pro tanto do- 
 ing the work of the Stale. He devotes his property to a public use. The 
 State doing the work fixes the price for the use. It does not lose the right 
 to fix the price because an individual voluntarily undertakes to do the 
 work," Budd v. New York, 143 U.S. 549, 12 Sup. Ct. 468; "A railroad 
 corporation is an artificial person, created by positive law, and invested 
 with franchises involving specific powers and privileges, conferring some 
 of the attributes of sovereignly, to be exercised primarily for the benefits 
 and advantages of the public," Bradley v. Ohio River, etc., R.R. Co., 
 78 Fed. 387; Olcott v. The Supervisors, 16 Wallace, 695, 83 U.S. 678; 
 Munn v. Illinois, 94 U.S. 113, 24 L. ed. 72. See also Railroad Commission 
 v. P. & O. C. R. Co., 63 Me. 269; Banker v. L.I. R.R. Co., 89 Hun (N.Y.) 
 202; Beekman v. Saratoga, etc., R.R. Co., 3 Paige, 45; Bloodgood v. Mo- 
 hawk and Hudson R.R. Co., 18 Wendell, 1 ; Worcester v. R.R. Co., 4 Met- 
 calf, 564.
 
 THE BASIS OF REGULATION 17 
 
 to state the aims, not the basis, of regulation. Monopoly in 
 the Munn Case merely emphasized and pointed out the 
 public nature of the business. 1 Any serious threat against 
 the availability or extent of any essential service, whether 
 by way of competitive strife and duplication, excessive 
 cost of production, or monopolistic prices and limitation of 
 service for monopolistic gain is sufficient to create a "public 
 interest." 
 
 The public nature of certain industries, re-enunciated in 
 the Munn and Olcott Cases, has been recognized from the 
 earliest stages of governmental development. Usually gov- 
 ernment ownership and operation have preceded the dele- 
 gation of authority to private individuals. The quasi- 
 private nature of the public business has developed since 
 private wealth has been accumulated in large amounts 
 and public needs have grown faster than government re- 
 sources. 
 
 Highways, inns, and water-supplies have always been 
 government industries. The Hindoos, Babylonians, Assyri- 
 ans, Phoenicians, Persians, and other ancient peoples de- 
 veloped extensive highways, lined them with trees, set 
 mile-stones, and provided inns, resting-places and wells for 
 travelers. The antiquity of public water systems is testified 
 to by the great aqueducts of Rome and the ancient public 
 wells. 
 
 A thousand years ago China developed a network of 
 State canals. Three centuries before, an Egyptian king 
 
 1 An attempt has been made by some writers to base regulation upon 
 the franchise privilege, the grant of the power of eminent domain, and 
 State aid. These privileges, however, like regulation itself, are but a result 
 of the public nature of the business. The undertaking is not public because 
 such concessions are granted. The privileges are extended and regulation 
 is enforced because the business is public. Property acquired by condem- 
 nation proceedings and used under franchise restrictions in a privileged 
 undertaking is, of course, subject to an appreciable encumbrance which 
 directly affects its use and value. The fundamental basis of this encum- 
 brance, however, is the public interest which justifies both the use of emi- 
 nent domain and the franchise grant.
 
 18 FAIR VALUE 
 
 constructed the Suez Canal. The Royal Canal uniting the 
 Tigris and Euphrates was completed about 600 b.c. The 
 Moors built artificial government waterways in Spain. 
 Alexander the Great covered Egypt with a network of 
 waterways, and Marius and Claudius constructed govern- 
 ment canals in Rome. The public character of artificial 
 waterways has always been predominant. 
 
 The coming of the turnpike and railway did not alter the 
 nature of the undertaking. Improvements in the highways 
 only served to emphasize the public character of the trans- 
 portation service. Many more of the State's subjects be- 
 came directly affected. The need for means of commu- 
 nication became greater. The utility of the service to the 
 Government increased. The relation of the transportation 
 system to the distribution of wealth, to all industrial ac- 
 tivities, to all orderly human relations, and to the progress 
 and welfare of the State became more complex. The govern- 
 mental character of the service became more apparent. 
 
 The telegraph, telephone, express, bus-line, and pipe- 
 line possess the same characteristics which made the older 
 means of transportation public. The utilities furnishing 
 transport and other communication service form the physi- 
 cal basis and instrumentality of all modern political, social, 
 and economic organizations. They underlie every govern- 
 mental, industrial, and social institution. Without them it 
 would be impossible to build or maintain a prosperous com- 
 munity or extensive industrial organization. Their exist- 
 ence in a permanent, adequate, well-organized form is 
 scarcely less important to Government to-day than sover- 
 eignty itself. They are the military, political, economic 
 tools of the Government. Tbeir construction, maintenance, 
 and conduct, be it by private individuals or public officials, 
 is essentially a public function, a part of the State's police 
 power based, not alone upon the ministration to the public 
 welfare, but upon public safety and necessity. 
 
 The same general characteristics determine the status of
 
 THE BASIS OF REGULATION 19 
 
 the wharfinger and the warehouseman. And the considera- 
 tions which made the water system a public utility have 
 placed the gas and electric systems in that class. Storage is 
 communication between time factors, and the services it 
 renders have come to play almost as important a part in 
 modern industry as those rendered by other communication 
 utilities. Warehousing, on account of its relationship to 
 transportation and to the supply of limited necessities, has 
 a public interest — the specific interest involved in the 
 Munn decision. Utilities supplying necessities, such as wa- 
 ter, light, and heat from a common source, are as essential 
 to the safety and welfare of the community, under the mod- 
 ern system of industrial and social organizations, as com- 
 munication itself. Unimportant sections may do without 
 either service, but it is impossible to conceive of a modern 
 metropolis with individual water supplies, lighted by 
 candles or oil lamps, heated by stoves or ranges. The urban 
 life, made possible by the development of the communicat- 
 ing utilities, has emphasized the public character of and 
 developed new forms of the limited necessities utilities. 
 
 Those attributes denominated "public interest" in the 
 Munn Case are found in the final analysis of all public utili- 
 ties. All are necessary to the public welfare to such an ex- 
 tent that the State, to reach its own complete development, 
 must supply the service they render or a substitute for it. 
 The governmental function, i.e., the guarantee of the serv- 
 ice, with the power to operate if necessary, as opposed to 
 the exercise of the function, has never been delegated and 
 cannot be delegated without violation of legal principles. 1 
 
 1 Goezler v. Georgetown, 6 Wheat. 593; E. Hartford v. Hartford Bridge 
 Co., 10 How. 511; Boyd v. Alabama, 94 U.S. 645: "The right to regulate 
 the charges of railroads for transportation is one of the powers of the State, 
 inherent in every sovereignty, to be exercised by the legislature from time 
 to time at its pleasure, and hence one legislature cannot, by a charter 
 granted to a railroad company, though for valuable consideration, confer 
 on such railroad company a right to charge rates for transportation which 
 shall be beyond the control of subsequent legislatures." Laurel Fork & 
 S.H.R. Co. v. West Virginia Trans. Co., 25 W.Va. 324: "The legislature
 
 20 FAIR VALUE 
 
 Expediency alone has directed the waiver of the right to 
 serve by the State to private capital. Necessity has reserved 
 to the State the right to regulate. 
 
 X. Judicial Recognition of the Public Interest 
 
 That point in the Munn decision which recognizes the 
 
 public nature of the utility business and the resulting power 
 
 of regulation has been affirmed by the Supreme Court in 
 
 a long line of cases. 1 
 
 cannot, by any contract, divest itself of the power to provide for the 
 objects (preservation of good order and the public morals). They belong 
 emphatically to that class of objects which demand the application of the 
 maxim, 'salus populi suprema lex ' ; and they are to be attained and pro- 
 vided for by such appropriate means as the legislative discretion may de- 
 vise. That discretion can no more be bargained away than the power 
 itself." Boston Beer Co. v. Massachusetts, 97 U.S. 25, 33; Stone v. Miss- 
 issippi, 101 U.S. 814, 25 L. ed. 1079; Butchers' Union Slaughter House Co. 
 e>. Crescent City Live Stock Landing Co., Ill U.S. 746, 16 Wall. 36; New 
 York & N. E. R.R. Co. v. Bristol, 151 U.S. 556, 14 Sup. Ct. 437, 38 L. ed. 
 269; PearsahV Great Northern Ry. Co., 161 U.S. 646, 16 Sup. Ct. 705; St. 
 Louis & S. F. R.R. Co. v. Mathews, 165 U.S. 1, 17 Sup. Ct. 243, 41 L. ed. 61 1 ; 
 New Orleans Gaslight Co. v. Drainage Comm., 197 U.S. 453, 25 Sup. Ct. 
 471; Northern Pacific R.R. Co. v. Duluth, 208 U.S. 583, 28 Sup. Ct. 341, 
 
 52 L. ed. 630; American Union Tel. Co. v. Western Union Telg. Co., 67 
 Ala. 26; Birmingham Mineral R.R. Co. v. Parsons, 100 Ala. 662, 13 So. 
 602; Danville o. Danville Water Co., 178 111. 299, 53 N.E. 118, 60 Am. St. 
 Rep. 304, and 180 111. 235; Rogers Park Water Co. v. Fergus, 178 111. 571, 
 
 53 N.E. 363; Freeport Water Co. v. Freeport, 186 111. 179, 57 N.E. 862; 
 Venner v. Chicago City R.R. Co., 246 111. 170; Public Service Comm. of 
 Montana v. City of Helena, 52 Mont. 527, etc. 
 
 1 Spring Valley Water-Works v. Schottler, 110 U.S. 347, 4 Sup. Ct. 48, 24 
 L. ed. 173; Wabash, etc., R.R. Co. v. Illinois, 118 U.S. 557; Down. Beidel- 
 man, 125 U.S. 680, 8 Sup. Ct. 1028; Georgia R. & Banking Co. v. Smith, 
 128 U.S. 174, 9 Sup. Ct. 47, 32 L. ed. 377; Chicago, Mil. & St. P. R.R. Co. 
 v. Minnesota, 134 U.S. 418, 10 Sup. Ct. 462; Chicago & G. T. R.R. Co. v. 
 Wellman, 143 U.S. 418, Reagan v. Farmers' Loan & Trust Co., 154 U.S. 
 362, 14 Sup. Ct. 180, 38 L. ed. 1014; St. Louis & S. F. R.R. Co. v. Gill, 156 
 U.S. 649, 15 Sup. Ct. 484, 39 L. ed. 567; Covington & L. Turnpike R.R. 
 Co. v. Sanford, 164 U.S. 578, 17 Sup. Ct. 198; Smyth v. Ames, 169 U.S. 
 
 466. 18 Sup. Ct. 418, 42 L. ed. 819; Lake Shore, etc., Ry. v. Ohio, 173 U.S. 
 
 285. 19 Sup. Ct. 465, 43 L. ed. 702; San Diego Land & Town Co. v. National 
 City, 174 U.S. 739, 19 Sup. Ct. 804, 43 L. ed. 1154; Chicago, Mil. & St. 
 P. R.R. Co. v. Tompkins, 176 U.S. 167, 44 L. ed. 418, 20 Sup. Ct. 336; 
 Michigan Central R.R. Co. v. Michigan R.R. Comm., 236 U.S. 615, 59 
 L. ed. 750.
 
 THE BASIS OF REGULATION 21 
 
 In the case of Brass v. North Dakota 1 the Court took up 
 the issue where it had left it in the Munn decision and 
 thrashed out the monopoly doctrine of regulation. In the 
 face of able argument by counsel and a strong dissenting 
 opinion based squarely on the theory that virtual monopoly 
 is necessary to warrant governmental regulation, under the 
 doctrine of the Munn Case, the Court held that it is the 
 public nature and not the monopolistic character which 
 justifies control of a business as a public utility. 2 
 
 In Budd v. New York, 3 in a suit brought to test the con- 
 
 1 153 U.S. 391, 14 Sup. Ct. 857, 38 L. ed. 757, 4 1.C.C. Rep. 670. 
 
 2 A similar stand had been taken by the Supreme Court of Kentucky 
 even before the Munn decision in Nash v. Page, 80 Ky. 539, 44 Am. Rep. 
 490, where it was held that the warehousing of tobacco was a public busi- 
 ness because of the importance of the tobacco industry to the State and 
 the power exercised over the industry by the warehouses. The question of 
 monopoly was not brought into the case. It turned squarely on the public 
 function theory. See also Delaware, etc., R.R. v. Central Stock Yd. Co. 45 
 N.J. Eq. 50, 6 L.R.A. 855; Belcher, etc., Co. v. St. Louis Grain Elevator, 
 101 Mo. 192, 13 S.W. 822, 8 L.R.A. 801; McCullough p. Brown, 41 S.C. 
 247; Stewart v. Great N. Ry., 65 Minn. 517; Rippe v. Back, 56 Minn. 
 108; Vega S.S. Co. v. Consol. Elev. Co., 75 Minn. 312, 77 N.W. 973, 43 
 L.R.A. 843, 74 Am. St. Rep. 484; etc. 
 
 8 143 U.S. 547, 12 Sup. Ct. 468. The Court quoted the decision of the 
 lower court with approval, thus: " It affirmed that while no general power 
 resided in the legislature to regulate private business, prescribe the condi- 
 tions under which it should be conducted, for the price of commodities or 
 service, or interfere with the freedom of contracts and while the merchant, 
 manufacturer, artisan and laborer under our system of government, are 
 left to pursue and provide for their own interests in their own way untram- 
 meled by burdensome and restrictive regulations, which, however common 
 in rude and irregular times, are inconsistent with constitutional liberty, 
 yet there might be special conditions and circumstances which brought the 
 business of elevating grain within principles which, by the common law 
 and the practice of free governments, justified legislative control and regu- 
 lation in the particular case, so that the statute would be constitutional; 
 that the control which, by common law and by statute, was exercised over 
 common carriers, was conclusive upon the point that the right of the leg- 
 islature to regulate the charges for service in connection with the use of 
 property, did not depend in every case upon the question whether there was a 
 legal monopoly or whether special governmental privileges or protection had 
 been bestowed; that there were elements of publicity in the business of elevating 
 grain which peculiarly affected it with a public interest ; that those elements 
 were found in the nature and extent of the business, its relation to the com-
 
 22 FAIR VALUE 
 
 stitutionality of a New York statute fixing warehouse rates, 
 the Court sustained the Munn Case, holding it in conform- 
 ity with the Brass decision. The public nature of the busi- 
 ness, not the monopolistic tendency, was held to govern. 
 The decision, however, adds little to the previous holdings. 
 In Cotting v. The Kansas City Stock Yards et al., 1 the 
 Court for the first time since the Olcott Case distinguishes 
 clearly between a private business subjected to regulation 
 and a public business privately conducted. After reviewing 
 in detail the long line of decisions upholding the Munn Case 
 the Court said: 
 
 In the light of these quotations, this may be affirmed to be the 
 present scope of the decisions of this Court in respect to the power 
 of the legislature in regulating rates as to those individuals and 
 
 merce of the State and country and the practical monopoly enjoyed by 
 those engaged in it . . . that in view of the foregoing exceptional circum- 
 stances, the business of elevating grain was affected with a public interest 
 within the language of Lord Chief Justice Hale, in his treatise De Portibus 
 Maris (Haig, Law Tracts, 78), that the business fell within the principle 
 which permitted the legislature to regulate the business of common carriers, 
 ferrymen, and hackmen, and interest on the use of money, and that the un- 
 derlying principle was that business of certain kinds holds such a peculiar 
 relation to the public interest that there is superinduced upon it the right 
 of public regulation; and that the court rested the power of the legislature to 
 control and regulate elevator charges upon the nature and extent of the business, 
 the existence of a virtual monopoly, the benefit derived from the Erie Canal's 
 creating the business and making it possible, the interest to trade and com- 
 merce, the relation of the business to the property and welfare of the state and 
 the practice of the legislature in analogous cases, collectively creating an ex- 
 ceptional case and justifying legislative regulation." 
 
 1 Cotting v. Goddard, 183 U.S. 79, 22 Sup. Ct. 30. When a man volun- 
 tarily undertakes a public service which the State might perform, "He ex- 
 presses his willingness to do the work of the State aware that the State in the 
 discharge of its public duties is not guided solely by a question of profit. It 
 may rightfully determine that the particular service is of such importance to 
 the public that it may be conducted at a pecuniary loss, having in view a 
 larger general interest. At any rate, it does not perform its services with the 
 single idea of profit. Its thought is the general public welfare. If, in such a 
 case, an individual is willing to undertake the work of the State, may it not 
 be urged that he in a measure subjects himself to the same rules of action, 
 and that if the body which expresses the judgment of the State believes 
 that the particular service should be rendered without profit, he is not at 
 liberty to complain?" Ibid. 93.
 
 THE BASIS OF REGULATION 23 
 
 corporations who have devoted their property to a use in which the 
 public has an interest, although not engaged in a work of a confessedly 
 public character, there has been no further ruling than that the 
 State may prescribe and enforce reasonable charges. What shall I 
 be the test of reasonableness in those charges is absolutely undis- 
 closed. 
 
 As to parties engaged in performing a public service while the 
 power to regulate has been sustained, negatively, the Court has 
 held that the legislature may not prescribe rates which if enforced i 
 would amount to a confiscation of property. . . . 
 
 In reference to this latter class of cases [property devoted to a 
 use affected with a public interest], which is alone the subject 
 of present inquiry, it must be noticed that the individual is not 
 doing the work of the State. He is not using his property in the 
 discharge of a purely public service. He acquires from the State 
 none of its governmental powers. His business in all matters of 
 purchase and sale is subject to the ordinary conditions of the 
 market and the freedom of contract . . . while he cannot claim 
 immunity from all State regulation he may rightfully say that i 
 such regulation shall not operate to deprive him of the ordinary 
 privileges of others engaged in mercantile businesses. 
 
 Pursuing his thought, we add that the State's regulation of his 
 charges is not to be measured by the aggregate of his profits, de- 
 termined by the volume of business, but by the question whether 
 any particular charge to an individual dealing with him is, con- 
 sidering the service rendered, an unreasonable exaction. In other 
 words, if he has a thousand transactionsa day, and his charges in 
 each are but a reasonable compensation for the benefit received by 
 the party dealing with him, such charges do not become unreason- 
 able because, by reason of the multitude, the aggregate of his 
 profits is large. The question is not how much he makes out of his 
 volume of business, but whether in each particular transaction 
 the charge is an unreasonable exaction for the services rendered. 
 
 The court definitely states the public nature of the busi- 
 ness and points out the difference in control of a public and 
 private undertaking. The specific immediate reason for con- 
 trol may be monopoly profit in both cases, but need not be 
 in public-service cases. The governmental character of the | 
 service creates the distinction which submits the utility to 
 the more rigid control. The public welfare can best be 
 served by limiting individual rights in the one case, and en-
 
 24 FAIR VALUE 
 
 couraging individual action in the other by refraining from 
 limiting personal rights. The public has an interest in prof- 
 its in the one case, in rates and service only in the other. 
 The one operator has undertaken to discharge a govern- 
 mental function, the other to conduct a private business. 
 
 The only step which remains is to hold that a business 
 admittedly private may "become affected with a public 
 interest"; by change of circumstances which render it of 
 such vital import to the community at large as to make 
 it a public calling and subject it to the more rigid regu- 
 lation. The German Alliance Insurance Case decided by 
 the Supreme Court in 1913 x definitely affirms the first 
 
 1 German Alliance Insurance Co. v. Lewis, 233 U.S. 389, 58 L. ed. 1011, 
 42 L.R.A. (n.s.) 1000. The Court said: "The cases need no explanatory or 
 fortifying comment. They demonstrate that a business, by circumstances 
 and its nature, may rise from private to be of public concern, and be subject, 
 in consequence, to governmental regulation. And they demonstrate . . . that 
 the attempts made to place the right of public regulation in the cases in 
 which it has been exerted, and of which we have given examples upon the 
 ground of special privilege conferred by the public on those affected, can- 
 not be supported. The underlying principle is that business of certain kinds 
 holds such a peculiar relation to the public interest that there is superinduced 
 upon it the right of public regidation. ... It would be a bold thing to say 
 that the principle is fixed, inelastic, in the precedents of the past, and can- 
 not be applied though modern economic conditions may make necessary 
 or beneficial its application. In other words, to say that government pos- 
 sessed at one time a greater power to recognize the public interest in a busi- 
 ness and its regulation to promote the general welfare than government 
 possesses to-day. . . . 
 
 " It would be very rudimentary to say that measures of government are 
 determined by circumstances, by the presence or imminence of conditions, 
 and of the legislative judgment of the means or the policy of removing or 
 preventing them. The power to regulate interstate commerce existed for a 
 century before the Interstate Commerce Act was passed, and the commis- 
 sion constituted by it was not given authority to fix rates until some years 
 afterwards. Of the agencies which those measures were enacted to regulate 
 at the time of the creation of the power, there was no prophecy or concep- 
 tion. Nor was regulation immediate upon their existence. It was exerted 
 only when the size, number, and influence of those agencies had so in- 
 creased and developed as to seem to make it imperative. Other illus- 
 trations readily occur which repel the intimation that the inactivity 
 of a power, however prolonged, militates against its legality when it is 
 exercised. . . ."
 
 THE BASIS OF REGULATION 25 
 
 proposition, and by unavoidable inference establishes the 
 second. 
 
 This decision considered with the Cotting Case estab- 
 lishes the fact that two distinct types of industry may be 
 regulated under the police power. The first class includes 
 public utilities whose service is such that the Government 
 must guarantee it to the community. Such industries must 
 serve all comers. The service they render is a public one 
 which all may demand as their right. The public has a di- 
 rect interest in the profit they make. The second class con- 
 sists of those industries, which because of their power to al- 
 ter existing conditions of production and distribution have 
 a direct influence upon the public welfare, but which do not 
 exercise a governmental function or render a service so es- 
 sential to the public that the State must guarantee it. Such 
 business, in the absence of statutory requirement, need not 
 serve all consumers. It may be required to serve at reason- 
 able rates when service is rendered, but the public has no 
 interest in its profits and cannot legislate for the express 
 purpose of limiting them. 
 
 XI. Summary 
 
 To summarize, the basis of regulation is found in the 
 theory of private property. Government control is but the 
 exercise of a necessary sovereign power to protect the pub- 
 lic interest in private property. Such protection, though it 
 limits the individual rights, is essential to the existence of 
 private property itself. 
 
 The property which is devoted to a public use, however, 
 is singled out for more rigid control than other private 
 wealth. This discrimination is based upon the fact that the 
 owner has sought to make private gain by rendering a gov- 
 ernmental service. He has volunteered for an undertaking 
 of such vital interest to the public that the Government, 
 though it has waived the right to conduct the business it- 
 self, must see that the service is adequately rendered at a 
 fair rate under reasonable conditions.
 
 26 FAIR VALUE 
 
 The property devoted to the governmental service re- 
 mains private, but because of the peculiar use the public in- 
 terest, present in all private property, is emphasized. The 
 property is subjected to a real encumbrance which not 
 only changes but decreases its value. So long as the encum- 
 brance exists the bundle of property rights is diminished. 
 The property has undergone an actual change. Fewer 
 rights exist. The social side of the property becomes domi- 
 nant because the use is more vital to society. The distinc- 
 tive features of utility regulation are based upon the neces- 
 sity of protecting this public interest.
 
 CHAPTER II 
 THE PURPOSE OF REGULATION 
 
 I. Regulation and Private Interest 
 
 Regulation is necessarily antagonistic to the individual 
 interests regulated. Government control limits private 
 rights. It is negative and restrictive, not positive or con- 
 structive. The police power, under which regulation is ex- 
 ercised, is a restrictive power. The functions of government 
 are qualified by the limitation that they must promote the 
 public good with the least possible interference in private 
 affairs. The laissez-faire economic and legal systems, still 
 dominant in this country, have emphasized this restriction. 
 Affirmative interference, even in the interest of the public, 
 has been almost impossible. Such progress as has been made 
 in protecting the social element in private property has 
 been possible only by restrictive action. 
 
 Regulation, because it is restrictive, appears destructive. 
 Its immediate result is destruction, though its ultimate aim 
 and effect are positive and constructive. Regulation par- 
 tially destroys property and property rights by limiting the 
 bundle of rights which constitute property. It destroys 
 individual freedom by limiting the use of property and re- 
 straining personal action. It destroys value by destroying 
 property rights, encumbering property, and limiting profits. 
 Whenever the individual interest and the public interest 
 conflict, to such an extent that regulation becomes neces- 
 sary, the individual interest is destroyed in whole or in part 
 as expediency dictates. 
 
 The aim of regulation is the destruction of certain indi- 
 vidual rights. This fact cannot be too emphatically pointed 
 out. Failure to recognize it has produced much of the con- 
 fusion in discussions of regulation and valuation. It has
 
 28 FAIR VALUE 
 
 produced a widespread misconception of the "due-process" 
 limitation of the Fourteenth Amendment by portraying 
 it as prohibiting all destruction of value without com- 
 pensation. It has obscured both the aim and basis of 
 regulation. 
 
 The basis of utility control is the public interest in the 
 business, i.e., the necessity that the common good be pro- 
 tected through the police power by enforcing adequate, con- 
 tinuous, non-discriminatory service at reasonable rates. 
 The aims of regulation, though negative and destructive, 
 must be similarly stated in terms of the public welfare. 
 
 II. Service Requirements 
 
 The chief objective of regulation must be adequate serv- 
 ice. Public-service corporations are the physical basis and \ 
 instrumentality of all political, social, and economic organ- 
 ization, and underlie every governmental, industrial, and 
 social institution. Their existence in a permanent, adequate, 
 well-organized form is essential to the fulfillment of the 
 purposes of government. They are its military, political, 
 and economic tools. 
 
 Adequate service can be secured only when regulatory 
 measures are passed with this particular aim in view. If the 
 community is firmly committed to private ownership, it 
 must enact laws which will supply the incentive necessary 
 to induce capital to enter the field in amounts sufficient/ 
 properly to develop the service. Rate and financial legisla- 
 tion must be adjusted to that end, or the aim accomplished 
 by subsidies. Poor service and inadequate development 
 will follow unless such a policy is adopted, or unless the 
 business is taken over by the public. , 
 
 The regulatory system adopted must be framed to secure 
 continuous as well as adequate service. Rates must provide 
 for accruing depreciation. Financial regulations and returns 
 must be adjusted to attract capital for necessary additions 
 and betterments.
 
 THE PURPOSE OF REGULATION 29 
 
 III. Rate Regulation 
 
 Regulation cannot pause when adequate and continuous 
 service are secured. All forms of discrimination and rebat- 
 ing must be prohibited and rate schedules made upon a 
 scientific basis fair to all consumers. 
 
 The rates fixed must be low enough to encourage general 
 use of the service, or all other features of regulation will be 
 nullified. This phase of regulation is all-important. It is 
 only through general use that the utility service can build 
 up the community and promote the public welfare. It is 
 in part because private interests may be better served by 
 rendering a more expensive service to few consumers than 
 by a cheaper service offered many that regulation is neces- 
 sary. The aim of government control must be to extend the 
 service as far as it may reasonably be developed under the 
 particular circumstances. This aim makes rate regulation 
 more than a mere artificial enforcement of restraints equiv- 
 alent to those of competition. 
 
 IV. The Social Side of Regulation 
 
 Important as low rates are, however, the charges must 
 be fair to the utility if successful private operation is ex- 
 pected. The~cfisputed question in rate regulation is, Shall 
 the schedule be drafted primarily to protect private prop- 
 erty rights or to promote the public welfare? It is because 
 this question underlies the whole problem of utility con- 
 trol that such space has been devoted to discussion of the 
 purpose, dual nature, and legal status of private property 
 devoted to a public use. 
 
 The interests of the utility and public are widely con- 
 ceived of as necessarily antagonistic. The short-sighted 
 rush for gain by both has made their interests actually 
 antagonistic in the past. A successful regulatory system, 
 based upon private operation, must recognize that the 
 utility and public have many interests in common. Where 
 those interests conflict, public rights must predominate,
 
 30 FAIR VALUE 
 
 since the whole purpose of regulation is to serve the com- 
 mon good. Where private property interests are really ad- 
 verse to the public welfare, they must be destroyed be- 
 cause private property itself exists only to promote the 
 public good and private interests can be furthered only 
 by promotion of the common weal. The moment the indi- 
 vidualistic side of private property is emphasized at the 
 expense of the social side, the fundamental property rights 
 themselves are threatened. If the question is vital the so- 
 cial interest must predominate. 
 
 The social-welfare element, therefore, is constantly be- 
 coming more prominent in regulation. No well-balanced 
 regulatory system can neglect it. Commutation fares 
 must be offered to counteract the congestion of population 
 in thickly settled city districts. Reduced transportation 
 rates should be secured for school-children. Transportation, 
 gas, and electric charges should be reduced to encourage 
 general use of the service, develop the community, foster 
 industry, and raise the general standard of living. Trans- 
 portation rate schedules and classifications must be drafted 
 to encourage the movement of low-class freight and raw 
 material to aid production, and to encourage immigration 
 to assist in the distribution of population. The primary ob- 
 ject of regulation is the economic betterment of society. 
 
 The purpose of regulation is apparent. The expedient 
 means are determined with greater difficulty, especially 
 when the property employed in the public service is pri- 
 vate. The system of private operation is essentially a lim- 
 itation upon the pure public-welfare theory. It is far from 
 inconceivable that the public interest may demand opera- 
 tion at an unremunerative rate, even after the development 
 period of the service has passed. It might be deemed a wise 
 legislative policy to supply cheap transportation, light, 
 heat, power, or water to raise the standard of living, develop 
 the community, build up an industrial center, attract pop- 
 ulation, and lower the price of manufactured goods. Such
 
 THE PURPOSE OF REGULATION SI 
 
 legislation accords with present theories of social better- 
 ment, has been widely experimented with on the Conti- 
 nent, and is not unknown in this country. But private 
 ownership is poorly adapted to such a programme because 
 an adequate return upon the capital invested is the first es- J 
 sential of such a system. Social and economic betterment 
 rates not remunerative to the utility owners can be se- 
 cured only by way of subsidizing the plant; and subsidies 
 are not looked upon with favor, have not proved satisfac- 
 tory, and are necessarily indirect and open to misuse. Pub- 
 lic ownership, though not always expedient, is the only 
 logical solution of the social betterment problem. 
 
 V. Northern Pacific Railway v. North Dakota 
 
 The adoption of private ownership of utility property in 
 the United States has not, however, completely closed the 
 door to social-welfare regulation. The decision which limits 
 public and entrenches private interest most is Northern 
 Pacific Railway v. North Dakota, 1 reversing Minnesota and 
 St. Louis Railroad v. Minnesota. 2 In the Dakota Case the 
 
 1 236 U.S. 585, 59 L. ed. 735. 
 
 2 186 U.S. 257, 46 L. ed. 1151, 22 Sup. Ct. 901. The Court said: "But, 
 while local interests may serve as a motive for enforcing reasonable rates, 
 it would be a very different matter to say that the State may compel a 
 carrier to maintain a rate upon a particular commodity that is less than 
 reasonable or — as it might equally well be asserted — gratuitously, in or- 
 der to build up a local enterprise. . . . The fact that the property is devoted 
 to a public use on certain terms does not justify the requirement that it 
 shall be devoted to other public purposes. . . . The public interest cannot 
 be invoked as justification for demands which pass the limits of reasonable 
 protection and seek to impose upon the carrier and its property burdens 
 that are not incident to its engagement. 
 
 "Where it is established that a commodity, or class of traffic, has been 
 segregated and a rate imposed which would compel the carrier to trans- 
 port it for less than the proper cost of transportation, or virtually at cost, 
 and thus the carrier would be denied a reasonable reward for its service 
 after taking into account the entire traffic to which the rate applies, it 
 must be concluded that the State has exceeded its authority. 
 
 " // in such a case there exists any practice, or what may be taken to be 
 (broadly speaking) a standard of rates with respect to that traffic, in the light of 
 which it is insisted that the rate should still be regarded as reasonable, that
 
 32 FAIR VALUE 
 
 Court ruled that it is not sufficient protection to private 
 rights to grant an adequate return upon the [whole schedule, 
 but that each rate must provide a reasonable return for the 
 service rendered. 
 
 Even this ruling, however, leaves opportunity for limited 
 social-betterment rate-making. The Court merely holds 
 that the rate must produce some return above the fair cost 
 of the service — an income reasonable for the kind of traffic 
 carried. The decision leaves room to draft rates to encour- 
 age the movement of low-class freight, since a rate for such 
 traffic might be held reasonable, though far below a figure 
 justifiable for other goods. 
 
 Much may be accomplished by adjusting the rate of re- 
 turn. 1 Social-welfare principles may be applied to fix the 
 percentage in each case. 
 
 A recent decision 2 holds that an order compelling a trac- 
 tion company to carry passengers at a loss over lines oper- 
 ated under a separate franchise, but as a part of a general 
 system, was not a violation of the due-process clause if a 
 reasonable income was earned upon the whole system. A 
 similar rule was laid down in the case of St. Louis, etc., 
 Railroad Company v. Gill. 3 
 
 An analogous rule has been adopted in the case of service 
 
 should be made to appear." This case has been approved by a long line of 
 subsequent holdings, largely, however, commission cases. See Norfolk and 
 Western Ry. v. Conley, 236 U.S. 605, 59 L. ed. 745; Union Pacific R.R. 
 Co. v. Public Utilities Comm. of Kansas, P.U.R. 1915-D-377; In re N.E. 
 Kansas Tel. Co., P.U.R. 1916-B-925; Butler v. Lewiston, A. & W. St. Ry. 
 Co. (Me.) P.U.R. 1916-D-25. 
 
 1 In commenting on Northern Pacific Ry. Co. v. North Dakota the 
 Court said, in Norfolk and Western Ry. v. Conley, 236 U.S. 605, 59 L. 
 ed. 735: "It was recognized that th» State has a broad field for the exer- 
 cise of its discretion in prescribing reasonable rates for common carriers 
 within its jurisdiction; that it is not necessary that there should be uni- 
 form rates or the same percentage of profit on every sort of business; 
 and that there is abundant room for reasonable classification and the 
 adaptation of rates to various groups of service." 
 
 2 Puget Sound Trac. L. & P. Co. v. Reynolds et al., 244 U.S. 574, 579, 
 61 L. ed. 1325. 
 
 8 156 U.S. 649, 15 Sup. Ct. 484, 39 L. ed. 567.
 
 THE PURPOSE OF REGULATION 33 
 
 orders. The Court has sustained rulings requiring utilities 
 to install additional facilities and render more adequate 
 service even at a loss, where the company was expressly 
 or impliedly obligated by its franchise privileges to meet 
 such requirements. 1 
 
 Thus, while the operation of the social-welfare principle 
 in rate-making is very much restricted, it is not wholly 
 blocked by private ownership. It may be successfully ap- 
 plied, within the limits stated, to railway rates in general, 2 
 without violating the prohibitions of the Fourteenth Amend- 
 ment. It may be applied with even wider results to other 
 utility rates. It must, under the changing economic and 
 social theories, become ever more and more a feature of 
 control if government ownership and operation are to be 
 avoided. 
 
 VI. Anti-Monopoly Regulation 
 
 Encouragement of extensive use of service by fixing rea- 
 sonable charges is of great import, but cheap rates are not 
 the chief aim of regulation. Nearly every decision has in- 
 
 1 Atlantic Coast Line v. N. Carolina Corp. Comm., 206 U.S. 1, 51 L. 
 ed. 933; see also Wisconsin Ry. Co. v. Jackson, 179 U.S. 287, 45 L. ed. 
 194, 21 Sup. Ct. 115; Louisville & Nashville R.R. v. Kentucky, 183 U.S. 
 503, 22 Sup. Ct. 95. 
 
 2 " Undoubtedly the cost of service represents the most important and in 
 many ways the fairest basis for fixing rates, but this basis cannot in all cases 
 be inflexibly applied, owing to the economic necessity for moving certain 
 traffic which could not be handled at all except at a relatively low rate." 
 Railroad Passenger Rate Case (Mass.) P.U.R. 1915-B-362, 367. 
 
 "The general comparatively low rating [of low-class commodities] is 
 largely due to the character of such commodities, the use to which they 
 are put, the demand for them in large quantities throughout the country, 
 their susceptibility of movement at less cost and risk to the carrier than 
 high-class and more valuable freight, and other like considerations. It is to 
 the interest of the carrier as well as the public that their rates be low enough^ 
 if not below a remunerative point, to permit the general movement and distri- 
 bution of these commodities in general demand in large quantities for 
 construction, building, manufacturing, and other purposes. Reasonable 
 freedom of such movement and distribution stimulates the growth and 
 development of the country and thereby promotes all interests." Colorado 
 Fuel & I. Co. v. Southern Pac. Ry. Co., 6 I.C.C. 489.
 
 34 FAIR VALUE 
 
 volved and emphasized the rate question, because, under 
 the laissez-faire policy, prices in the monopolistic utility 
 field were invariably above the reasonable figure. 
 
 The agitation which resulted in the Granger movement 
 was one to reduce charges. The low competitive rates 
 forced from interstate utilities by the industrial centers 
 made the higher non-competitive rates charged the Illinois 
 and Iowa farmers seem unreasonably high. The fall in 
 prices on the farmers' products coming just at this time 
 emphasized this phase of the dissatisfaction. Rebates and 
 individual discrimination were overlooked. A remedy for 
 the rate situation was sought in maximum-rate legislation. 
 
 The movement was not a complete reaction against the 
 laissez-faire policy. The aim was to regulate monopoly and 
 curb unreasonable profits. As the movement gained mo- 
 mentum it broadened to include a cure for rebates, unjust 
 discrimination between persons and localities, and the many 
 other evils of monopoly. 
 
 The period was anti-monopolistic. Competition was 
 considered a sufficient force, if properly fostered, to regu- 
 late monopoly profits, confine corporate growth within the 
 bounds of safety, and generally protect the public. The aim 
 of regulation was to curb monopoly, to foster competition, I 
 and to eliminate monopoly profits. The regulation sug- 
 gested was very similar to that since applied to the whole 
 field of general industry, but declared inexpedient in the 
 case of public-service companies. 
 
 VII. The Recognition of Regulated Monopoly 
 
 Since 1910 there has occurred a complete change in the 
 aims of public-utility regulation. The competitive theory 
 has been practically abandoned. The present movement 
 recognizes monopoly, particularly natural and legal monop- 
 oly, as a desirable element in the field and seeks to regulate 
 rather than destroy it. The day of regulation by competi- 
 tion in the field of public service has passed. Monopoly has
 
 THE PURPOSE OF REGULATION 35 
 
 come to stay. Regulation has replaced competition, but not 
 as a mere artificial competition installed because of the ab- 
 sence of, or undesirability of, the real element. 
 
 The force of competition as a regulatory element in rate 
 control rests on the fact that when competition in any form 
 is present, the rate will ultimately be forced, not to the 
 mean figure which will yield the greatest return, but below 
 that figure to approximately the cost of rendering the serv- 
 ice by the most disadvantageously located competitor. 
 This is true because if a higher rate is charged, the mar- 
 ginal producer who is struggling for existence will sell lower 
 and supply the demand, and new capital will be drawn into 
 the industry, thus forcing the price down. The normal price 
 under free competitive production and the only price which 
 can be stable in case of such production is one which approx- 
 imates the cost of production. 
 
 The competitive rate, therefore, is always below the un- 
 regulated monopolistic rate under the same productive con- 
 ditions. Moreover, the competitive theory fitted well to the 
 ragged ends of the previous laissez-faire policy. It complied 
 with the demands of those who held exalted ideas of the sa- 
 credness of private property and business rights. It required 
 no effort. It was conservative regulation; and it was adopted. 
 It was held on to tenaciously because it was conservative, 
 because it did conform to ideas of industrial freedom, and 
 because where competition existed it did lower rates. 
 
 During the earlier period of regulation no effective check 
 was placed upon monopoly. None was known, and monop- 
 oly was feared because it could not be controlled. The pe- 
 riod of the usefulness of uncontrolled monopoly passed, but 
 careful fostering during that period had developed legal 
 entities of seeming gigantic proportions, which rode over 
 both competition and legislation. Regulatory bodies saw no 
 loophole toward successful control save abolishing abso- 
 lutely and forever the object they deemed themselves in- 
 capable of controlling. Competition stood forth a shining
 
 36 FAIR VALUE 
 
 relic of past glory, an idea to be sought above all else. The 
 struggle to reinstate this fallen idol brought self-assurance, 
 brought legislative experience, and has led to the present 
 altered aim. 
 
 VIII. The Reasons for the Change 
 
 The reasons for the change from the competitive theory 
 to the recognition of regulated monopoly in the utility 
 field are not difficult to discover. Where virtual monopoly 
 exists, the competitive force fixing price near the cost of 
 production is lacking. If rates are limited the restriction 
 must be imposed by government regulation. The public- 
 utility company is monopolistic because duplication of 
 facilities and the uncertainty of competitive service are not 
 conducive to the greatest possible public benefits. Often 
 the utility combines both natural and legal monopoly. In 
 fact, the two differ in little but name in the public service 
 field, since natural monopoly seldom means real inability 
 to duplicate facilities or offer substitute service; in truth 
 means little but the inexpediency of granting more than one 
 permit to use natural facilities. The territory served can- 
 not afford an unnecessary duplication of rights of way, of 
 wires, conduits, pipes, and rails, particularly where such 
 facilities are located in, above, or below its streets. A legal 
 monopoly is granted. The securing of a duplicate right of 
 way becomes, in most cases, practically impossible, and so 
 expensive as to produce virtual monopoly for the first com- 
 pany in the field. Duplication always multiplies the capital 
 expenditure upon which a return must be provided by the 
 rates. And at the same time it decreases the number of con- 
 sumers who must pay the charges, thus raising the pro-rata 
 share of each. 
 
 The service which a public utility renders is usually not 
 in competition with any substitute service, and competi- 
 tion between similar utilities is undesirable. Competition 
 could not be accepted as a permanent regulatory force be-
 
 THE PURPOSE OF REGULATION 37 
 
 cause the corporations to be controlled were best operated 
 as monopolies. The competitive theory has had no real 
 place in regulation since the advantages of monopolistic 
 operation became apparent. 
 
 It is questionable whether, under modern industrial con- 
 ditions, the competitive theory of regulation could be suc- 
 cessfully applied even in the absence of natural and legal 
 monopoly. Competition keeps rates near the cost of pro- 
 duction, but also keeps that cost needlessly high. This is 
 particularly true in the case of distributive services such as 
 water, gas, electricity, telegraph, telephone, and common 
 carriage. A great part of the cost of service in such under- 
 takings is connected with the stringing of wires, laying of 
 mains, or construction of roadbed and track. Any duplica- 
 tion of this non-productive distribution system is a burden 
 upon the community which nearly if not completely elimi- 
 nates the possibility of lowering rates by way of competi- 
 tion. The cost of production would raise the competitive 
 rate above the monopolistic charge of a favorably located 
 single company. The funds wasted in needless and unpro- 
 ductive duplication could be used by a single concern to 
 extend its mains or wires into areas which could not be 
 reached at all if two companies occupied the field. 
 
 Competition is a defective regulatory force, under pres- 
 ent conditions, because it does not foster the public interest 
 in the undertaking and does not, take social welfare into 
 consideration. Although recognizing a difference between 
 the public utility and other industry which justifies regula- 
 tion of a different type, the competitive theory proceeds 
 to disregard that difference and apply the same control to 
 utilities and other industry. 
 
 Competition for these reasons has proven a regulatory 
 force unsatisfactory to both the utility and the public. 
 Monopoly has been accepted as the economic substitute 
 to eliminate the wastes of competition, but accepted sub- 
 ject to regulation to secure the benefits which competition
 
 38 FAIR VALUE 
 
 would have given and to guarantee to the public its share 
 of the savings from monopolistic operation. 
 
 The changed attitude of regulatory bodies toward monop- 
 oly is clearly expressed by the Public Utilities Commis- 
 sion of Illinois in the case of the Lake Shore and Michigan 
 Southern Railway Company, 1 wherein the Commission 
 said: 
 
 The consolidation will, of course, result in the formation of a 
 corporation of great magnitude with immense power which might, 
 in the absence of reasonable governmental supervision and con- 
 trol over its dealings with the public, exercise evil influences on 
 government, or become oppressive to the public; but the dangers 
 because of bigness which might be apprehended if unbridled free- 
 dom were to follow, cannot be regarded as a menace when the 
 greater power of the Government to regulate and control it is 
 properly exerted to prevent wrong and injustice. 
 
 This Commission is not opposed to unification, merger, or con- 
 solidation of public-service corporations in Illinois when the same 
 can be effected without violating some positive law. The constitu- 
 tional and statutory inhibitions against monopolies were designed 
 to preserve to the public such benefits as would accrue from com- 
 petition. Under the Public-Utilities Law of Illinois, however, am- 
 ple provision is made to safeguard more fully the interests of the 
 public through and by a commission organized to supervise, regu- 
 late, and control all public-service corporations in the matter of 
 reasonableness of rates to be charged, the adequacy of the service 
 
 1 I.P.U.C. No. 2495; see also State Pub. Utilities Comm. ex rel. Clow 
 v. Romberg (111. Sup. Ct.) P.U.R. 1917-B-355; State Public Utilities 
 Comm. ex rel. Pike County Tel. Co. v. Noble, 275 111. 121, P.U.R. 
 1917-A-520. The State regulatory commissions are unanimous in their 
 acceptance of regulated monopoly. 
 
 "The enactment clearly constitutes an expression of the legislative pol- 
 icy which, recognizing the evils which flow from duplication of the equip- 
 ment and facilities of public utilities, declares that regulated monopoly is 
 preferable to unrestricted competition in which the possibilities for waste 
 and dissatisfaction are limited only by the resources of the rivals and the 
 patience of the consumers. The clear intent of the statute, as has been said in 
 numerous decisions, is to -prevent competition in any given field so long as the 
 existing facilities are adequate or can be made so by the exercise of the 
 supervisory and corrective jurisdiction of this commission," Theresa Union 
 Tel. Co. v. East Valley Tel. Co. (Wis.) P.U.R. 1917-E-387, 394; Ft. Supply 
 T. & T. Co. v. Pioneer T. & T. Co. P.U.R. 1917-A-188, 191.
 
 THE PURPOSE OF REGULATION 39 
 
 to be rendered, and in the prevention of discrimination as to both 
 rates and service. 
 
 Formerly without reasonable regulation and control of public- 
 service corporations competition seemed to be the only method by 
 which the public interests could be protected, but with such com- 
 prehensive regulatory laws as are now in force in this state competi- 
 tion loses its forces as a corrective agency. 
 
 Monopoly having been accepted in the field of public- 
 utility service, the aim of future government regulation 
 must include the weeding-out of those natural evils which 
 have characterized monopoly in the past. Rates must be 
 controlled to keep them near the cost of production. Operat- 
 ing expenses must be supervised to keep the cost of pro- 
 duction low, and the accounting and financial activities of 
 the companies must be regulated to prevent circumvention 
 of regulation. 
 
 It is not the evils of monopoly alone, however, which 
 must be guarded against under a system of regulated mo- 
 nopoly. Competition must be eliminated to prevent need- 
 less duplication and waste. The regulatory force of com- 
 petition must be saved, advantage taken of the economic 
 benefits of monopoly, and the public interest substituted 
 for that of the individual competitor. \. 
 
 IX. Speculation 
 
 The most prominent phase of regulation outside the 
 sphere of monopoly is the control of speculation. In this 
 field, as in that of monopoly, the dangers were learned early. 
 The great development company bubbles and lotteries 
 taught the lesson. Here, too, early conditions were unfa- 
 vorable to regulation. Utility undertakings had to be given 
 the glamour of speculation to attract private capital and 
 encourage rush construction. Speculation in the public- 
 utility field was more pronounced than elsewhere. It had 
 run its course in other industries when the public-service 
 field was opened. There had been wild-cat banking, land 
 booms, and industrial bubbles. In these fields the specula-
 
 40 FAIR VALUE 
 
 tor was forced to play a game the people knew, but the pub- 
 lic-utility business was new. The changes affected by its 
 development were as revolutionary as the business itself. 
 The appeal of unlimited profits could be made. 
 
 The utility field was unoccupied. It offered temptations 
 to the speculator which no sphere already developed could 
 hold out. The public demanded the service. There was a 
 vast territory which required the utility for its develop- 
 ment. The eagerness of the people made them the easy prey 
 of the promoter. Land grants, bond issues, and subsidies 
 were secured without difficulty. And the development of 
 new territory opened the door to unlimited wealth, by way 
 of collateral investment, to the man on the spot and on the 
 inside of the development organization. 
 
 No one of all these forces which drew speculators from 
 other fields, however, was inherent in the nature of the 
 public-utility business. The utility differs from other in- 
 dustry, so far as speculation is concerned, only in the harm 
 which flows from inefficient control on account of the pub- 
 lic nature of the business. Effective regulation in the public 
 interest would be impossible if the law permitted the utility 
 to be made the pawn in ajspeculative game. Rate control, 
 based upon true economic principlesr^oes much to elimi- [ 
 nate the speculative element, but valuation not based on* 
 such principles reopens the door to the speculator and en- 
 dangers the interests of stockholders, bondholders, and 
 consumers. 
 
 Adequate, uninterrupted service can scarcely be ex- 
 pected, even under compulsion, when the undertaking is a 
 speculation rather than a sound business proposition. The 
 public interest and that of the gambler in utility securities 
 and utility service are wholly dissimilar. Regulation can be 
 made effective only by eliminating speculation and uncer- 
 tainty and placing the service on an economic basis. Com- 
 petition, even in a non-monopolistic field, cannot check 
 speculation, for competition is itself speculative and un-
 
 THE PURPOSE OF REGULATION 41 
 
 certain. The competitor entering a field already occupied 
 plays a spectacular game of chance staking his self-confi- 
 dence, an invention or a newer process against the train- 
 ing and going value of the existing concern. 
 
 X. Efficient Management 
 
 Rate schedules and financial legislation formed to pro- 
 duce a return that will attract capital, and at the same time 
 keep the price of service near the cost of producing it, would 
 prove ineffectual if that cost were permitted to be unduly 
 enhanced either by unnecessary capital expenditures or 
 unreasonable operating expenses. Any effective regulatory 
 system must enforce efficient management. And efficient 
 management can be insured only by means of a thorough, 
 compulsory cost system. It is impossible to regulate scientif- 
 ically on any other basis. Rate regulation must be founded 
 on cost. Depreciation must be accurately estimated and 
 provided for, and working capital held in proper ratio to 
 investment and service. Cost must be itemized to show 
 proper operation as a basis for credit, and point out possi- 
 ble savings in material and labor. 
 
 Regulation must attempt to produce a capitalization 
 reasonable in relation to the service performed and the cir- 
 cumstances under which it is rendered. It must aim to keep 
 operating expenses at a reasonable figure considering those 
 same elements. False capitalization, stock- watering, and 
 sharp financial practices must be eliminated. 
 
 Regulation must be shaped to counteract what Professor 
 Clark has spoken of as the failure of monopoly to make a 
 "proper use of that invaluable agent of progress, the junk 
 heap." 1 This aim may be accomplished by providing a 
 compu lsory depreci ation fund unavailable for general use 
 to offset the temptation to keep worn-out or antiquated 
 equipment in service. Such requirements should be supple- 
 mented by positive rules as to new equipment, construction, 
 1 Clark, The Control of Trusts, 2d ed. p. 14.
 
 42 FAIR VALUE 
 
 and standards of service, and by manipulation of the rate 
 of return to reward economic management. 
 
 Control must be exercised to prevent unnecessary salary 
 expenditure, unreasonable interference by holding compa- 
 nies, irrational investments in material and supplies, idle 
 property, excessive and poorly adapted or antiquated 
 equipment; to curb loss by leakage; to secure efficient or- 
 ganization and business methods; to limit the size of the 
 corporation and the territory covered, etc. Regulation 
 should not amount to management, but it cannot permit 
 management to defeat regulation. 
 
 XI. Financial Regulation 
 
 Any system of regulation which neglected the financial 
 transactions of the utilities would be powerless to check 
 speculation. Such a state of things would hopelessly handi- 
 cap rate-making. It would render attempts to force effi- 
 cient management futile. 
 
 Security issues must be permitted only upon a showing 
 of actual need for further capitalization, proof of the ex- 
 pediency of the type of financing proposed, and the proper 
 ratio of stock to bonds, etc. The terms of sale must be fixed 
 to assure an adequate return, and the sale expenses amor- 
 tized from income to prevent a padded capital account. 
 Where the aim is to secure funds for additions and better- 
 ments the propriety of the form and extent of equipment or 
 construction must be determined. 
 
 In the case of purchase and sale the capitalization of the 
 purchasing company must be limited to the fair value of the 
 property, irrespective of the sale price, and the price must 
 be held to approximately the fair value, to prevent handi- 
 capping the company by an excessive expenditure on which 
 a return cannot be earned. Where a part of the utility's 
 property is sold a corresponding decrease in capitalization 
 must be enforced or the resulting deficiency made good by 
 additions and betterments not charged to capital.
 
 THE PURPOSE OF REGULATION 43 
 
 In the case of a reorganization the capitalization must be 
 limited to the fair value of the property, and where consoli- 
 dation occurs capital must be restricted to the sum of the 
 outstanding securities of the consolidated companies plus 
 any additional capital actually invested at the time of con- 
 solidation. 1 
 
 XII. Accounting 
 
 The accounting features are among the most important 
 of the regulatory programme. Proper accounting methods 
 and investigations are the basis of publicity, of financial 
 regulation, of rate valuation, of every feature of control. A 
 uniform system of public-utility accounts is absolutely 
 necessary to show the service records, earnings, expenses, 
 and real investment. It alone can make possible reliable 
 comparison between utilities to show where economies may 
 be effected or to test reasonableness of charges. It only can 
 serve as the basis of the cost system upon which all regula- 
 tion is founded. 
 
 In the case of issues of securities the accounting system 
 must show the existing capitalization, the need for further 
 securities, the ratio of stock to bonds, and the expedient 
 form of security. It must follow the expenditure of the pro- 
 ceeds from the sale. It must enable regulation to protect 
 both the investor and the consumer. 
 
 In the case of rate investigations the accuracy of the orig- 
 inal-cost inventory depends upon the accounts required 
 by the regulatory system. The estimate of operating ex- 
 penses and working capital and the traffic survey are de- 
 pendent upon the accuracy of the accounts. The trustwor- 
 thiness of the inventory is affected by that of the accounts. 
 Every phase of rate control based on cost of service is de- 
 pendent upon accurate accounting. 
 
 1 It is questionable whether it would not even be better to restrict cap- 
 italization to actual value in the case of consolidations too, though many 
 of the Utilities Acts do not do so.
 
 44 FAIR VALUE 
 
 XIII. Summary 
 
 The full realization of the widest aims of utility regula- 
 tion, including the socialization of the service and the estab- 
 lishment of cheap rates to develop the territory and raise the 
 standard of living, is impossible under private ownership. 
 The purpose of a regulatory programme based on private 
 operation is primarily the protection of the public from the 
 private interests entrusted with the conduct of the service. 
 The aim is to secure adequate, continuous, non-discrimina- 
 tory service at rates which will attract sufficient capital 
 and yet keep the price of service near the cost. The public 
 interest is supreme. Private-property rights are involved 
 only incidentally, and only in so far as it is necessary to re- 
 spect them to secure the necessary capital and keep within 
 the prohibitory clauses of the Federal Constitution. 
 
 The many phases of government control constitute one 
 unified regulatory programme, every part of which is de- 
 pendent upon the successful operation of every other part. 
 Valuation is but one feature of public-utility regulation. 
 Both its form and aims are relative to the part of the general 
 programme, which it is called upon to carry out. Its consid- 
 eration apart from the other features of that programme 
 would be unintelligible.
 
 CHAPTER III 
 
 VALUATION AND REGULATION 
 
 I. Valuation a Judicial Theory 
 
 The place of valuation in public-utility regulatory pro- 
 grammes is essentially a legal question. Valuation theories 
 have been created wholly by Judicial decision. Economic 
 forces have but recently been permitted to influence valua- 
 tion principles. The present doctrine of the Federal Supreme 
 Court as to "fair value" is an artificial structure of piece- 
 meal construction, forming, not a unified whole based upon 
 economic principles, but a conglomerate mass shaped by 
 the varying issues presented in a number of separate cases. 
 The growth has been gradual. It has been almost haphaz- 
 ard. The court decisions have not been wholly consistent. 
 Even the individual holdings of the several members of the 
 Supreme Bench have lacked unity. No definitely stated or 
 clearly analyzed theory has been developed. Before at- 
 tempting to collect the fundamental principles of valuation 
 and analyze them, it is necessary, therefore, to follow the 
 development of the theory through the long line of deci- 
 sions which contain, but can scarcely be said to state, the 
 law. 
 
 II. The Granger Cases 
 
 In the Munn Case 1 the Court held without qualification 
 that the State legislative power may regulate rates where 
 the public has an interest in the business. The issue was the 
 constitutionality of a maximum-rate law. The State's au- 
 thority was unhesitatingly upheld. Rate-making was looked 
 
 1 94 U.S. 113, 24 L. ed. 72. See also Sinking-Fund Cases, 99 U.S. 700, 
 25 L. ed. 496; Spring Valley Waterworks p. Schottler, 110 U.S. 347. 
 4 Sup. Ct. 48, 24 L. ed. 173.
 
 46 FAIR VALUE 
 
 upon as a legitimate safeguard for the public welfare. Rate 
 regulation was regarded as a justifiable condition or limita- 
 tion upon the use of private property voluntarily devoted 
 to a public use for private gain. The claim of property 
 rights under the Fourteenth Amendment, which has since 
 become the basis of judicial review and a limitation upon 
 the State police power, was forcibly advanced by the util- 
 ities, and received consideration. The Court without falter- 
 ing, however, denied the claim with unmistakable empha- 
 sis, saying: 
 
 It is insisted, however, that the owner of property is entitled to 
 a reasonable compensation for its use, even though it be clothed 
 with a public interest, and that what is reasonable -is a judicial 
 and not a legislative question. 
 
 As has already been shown, the practice has been otherwise. In 
 countries where the common law prevails it has been customary 
 from time immemorial for the legislature to declare what shall be a 
 reasonable compensation under such circumstances. . . . 
 
 Rights of property which have been created by the common 
 law cannot be taken away without due process; but the law itself, 
 as a rule of conduct, may be changed at the will, or even at the 
 whim of the legislature, unless prevented by constitutional limita- 
 tion. . . . 
 
 We know that this is a power which may be abused, but that is 
 no argument against its existence. For -protection against abuses by 
 the legislature the people must resort to the polls, not the courts. 1 
 
 The dissenting opinion turned squarely upon the ques- 
 tion of property rights and gave to the Fourteenth Amend- 
 ment the interpretation that has since been adopted to pro- 
 tect private interest at the expense of public control. The 
 majority opinion was clear-cut and met the question 
 squarely. The Court encountered the exercise of a recog- 
 nized legislative power in a recognized field for a purpose 
 sanctioned by the common law. The rule, so often reaf- 
 
 1 " Where property has been clothed with a public interest, the legisla- 
 ture may fix a limit to that which shall in law be reasonable for its use. 
 This limit binds the courts, as well as the people. If it has been improperly 
 fixed, the legislature, not the courts, must be appealed to for the change." 
 Peik v. Chicago & Nw. Ry. Co., 94 U.S. 178.
 
 VALUATION AND REGULATION 47 
 
 firmed since the Munn Case, that the Court will not in- 
 quire into the expediency of the exercise of a legislative 
 power seemed controlling. The Court said: 
 
 Of the propriety of legislative interference within the scope of 
 legislative power, the legislature is the exclusive judge. 
 
 This repudiation of the theory of judicial review pre- 
 vented consideration of the alleged limitation upon the 
 State's police power. 
 
 The extent of the rate-making power arose again as an 
 issue in the case of the Chicago, Burlington and Quincy 
 Railroad Company v. Iowa. 1 In petitioning for an injunc- 
 tion to restrain the enforcement of the State maximum- 
 rate law the attorneys for the railroad contended that the 
 act violated the due-process clause of the Fourteenth 
 Amendment, advancing the argument that has since be- 
 come the controlling one in valuation cases. The argument 
 was rejected by implication. 2 
 
 The Court applied the strict theory of regulative con- 
 trol stated in the Munn Case. The issue was construed as 
 the protection of the public right to service at reasonable 
 charges from the rate-making attacks of a company fully 
 able to take care of itself. The plea of that company for 
 constitutional protection of its right to profit from the 
 property employed in the public service was subordinated 
 to the plea of the public for protection of its rights as de- 
 fined by the State legislative power. 
 
 The same question of property rights was advanced in 
 the case of Tilley v. S. F. and W. Railway Company 3 and 
 
 1 94 U.S. 155. 
 
 2 The Court said : " It was within the power of the company to call upon 
 the legislature to fix permanently this limit, and make it a part of the char- 
 ter; and if it was refused, to abstain from building the road and establish- 
 ing the contemplated business. If that had been done, the charter might 
 have presented a contract against future legislative interference. But it 
 was not, and the company invested its capital, relying upon the good 
 faith of the people and the wisdom and impartiality of legislators for pro- 
 tection against wrong under the form of legislative regulation." 
 
 3 5 Fed. 641.
 
 48 FAIR VALUE 
 
 valuation was suggested as the test in applying the alleged 
 constitutional limitation, but the Court declined to con- 
 sider it, saying: 
 
 The question whether the rates prescribed by the legislature 
 either directly or indirectly, are just and reasonable, is a question 
 which the legislature may determine for itself. 
 
 So long as the Court rejected the principle of judicial 
 review it was powerless to consider the question of reason- 
 ableness. Valuation and the other tests of rate-making 
 could receive no consideration in the decisions. 
 
 III. The Commission Cases 
 
 The question came up again nearly a decade after the 
 decision in the Munn Case, in the Railroad Commission 
 Cases, 1 being dragged in by the Court by way of dictum in 
 cases brought to restrain the Missouri Railroad Commis- 
 sion from fixing rates on the ground that the companies' 
 charters constituted contracts exempting them from State 
 rate control. The Court said: 
 
 From what has thus been said, it is not to be inferred that this 
 power of limitation or regulation is itself without limit. This 
 power to regulate is not a power to destroy and limitation is not 
 the equivalent of confiscation. Under pretense of regulating fares 
 and freight, the State cannot require a railroad corporation to 
 carry persons or property without reward; neither can it do that 
 which in law amounts to taking of private property for public use 
 without just compensation, or without due process of law. What 
 would have this effect we need not now say because no tariff has 
 yet been fixed. 
 
 Admittedly the question was not in issue, and the dic- 
 tum was not followed out in the decision. 
 
 The Court did not attack the regulatory power of the 
 State, but suggested for the first time a limitation on that 
 power. No intimation was given of the nature of the sug- 
 gested limitation, and no authority cited to prove its exist- 
 
 1 Stone v. Farmers' Loan & Trust Co., 116 U.S. 307, 6 Sup. Ct. 334.
 
 VALUATION AND REGULATION 49 
 
 ence. The authority to regulate rates within the limits 
 set was expressly upheld. 
 
 The question of valuation was brought directly to the 
 Court's attention by the statute in question, which directed 
 a revision of tariffs to permit a "fair and just return on the 
 value of such road, its appurtenances and equipment," but 
 the opinion did not consider the question. The dissenting 
 opinions of Justices Field and Harlan, however, took up the 
 subject and clearly repudiated valuation as a limitation 
 upon rate-making. 
 
 The case, in view of the strongly worded decisions in the 
 Granger Cases, can only be explained by the fact that just 
 at this time a sweeping change was taking place in the 
 views of the Supreme Court. The Court, because it is re- 
 quired to apply a legal system developed during the laissez- 
 faire period which unduly emphasizes individualistic theo- 
 ries and the protection of individual rights, has not been 
 inclined to respond to the reaction from the laissez-faire 
 doctrine. The growth of the legal concept which empha- 
 sizes the social duties and responsibilities attaching to the 
 individual and to private property has been slow. The 
 Granger Cases marked the awakening to the change. They 
 met with strong dissent. A change in the makeup of the 
 Court strengthened the minority. An opportunity to limit 
 the regulatory movement and establish the doctrine of ju- 
 dicial review was soon presented. The Fourteenth Amend- 
 ment, passed as a political war measure to conserve the 
 fruits of victory by protecting negro rights in the South, 
 was conceived of as applicable to the new and wholly un- 
 related subject of corporate rights. The due-process clause 
 of that amendment was judicially amended to make it 
 coextensive with the limitation imposed upon the Federal 
 Government by the Fifth Amendment. Influenced by the 
 new idea, the Court threw in the dictum of the Commission 
 Cases, that the legislative power of regulation is subject to 
 judicial limitation, and hastened on to declare a corporation
 
 50 FAIR VALUE 
 
 a person within the meaning of the amendment. The open- 
 ing thus offered for Federal judicial smothering of State 
 regulatory activity was instantly taken advantage of by 
 corporations crowding to seek safety from the excessive 
 rate legislation brought on by early corporate evils. Under 
 this pressure the Court, in direct reversal of the Granger 
 Cases, extended the meaning of "due process" to include 
 "taking property without just compensation," and ex- 
 tended its review jurisdiction to include the State police 
 power. 
 
 The majority opinion in the Commission Cases suggests 
 for the first time that legislative rate control is limited by 
 the confiscation clause. "Due process" receives a new con- 
 struction based upon taking private property without com- 
 pensation. The language of the decision is therefore de- 
 serving of note. The underlying thought is that the State 
 cannot require a railroad corporation to carry persons or 
 property without reward. The reasoning is unquestionably 
 sound. But in groping for a basis for the rule the Court 
 seems to have been led astray by the subtle suggestion of 
 counsel for the road, and the opinion continues, "neither 
 can it do that which in law amounts to taking of private 
 Y property for a public use without just compensation, or 
 due process of law." This too is a correct statement of an ab- 
 stract legal proposition, but the Court offers no valid ex- 
 cuse for coupling it with aught that has preceded either by 
 way of premise or conclusion. There is no attempt to show 
 that rate-making can or does enter the field of confiscation. 
 The Court, after volunteering the information, therefore 
 abandons the point with the statement that the question 
 was not before it anyway. 
 
 The opinion plunges the Court into the midst of a new 
 
 phase of the old Jeffersonian dispute as to the right of the 
 
 Court to declare a State law unconstitutional, started by 
 
 the decision in Marbury v. Madison. 1 A decision upholding 
 
 1 1 Cranch, 137, 2 L. ed. 60.
 
 VALUATION AND REGULATION 51 
 
 the Court's power was inevitable. The logical, economic, 
 and legal soundness of the decision, where the purpose of 
 private property and the aims of regulation are considered, 
 is not so apparent. The exercise of the police power par- 
 takes of the nature of a legislative declaration of what the 
 rights of private property within the State shall be. It de- 
 fines private property. The function is purely legislative. It 
 is one inherent in the State. The basis of the authority of 
 the Federal judiciary to interfere remains to be clearly 
 pointed out. It certainly was not definitely stated in the 
 Fourteenth Amendment. It has not been established to the 
 satisfaction of the average mind by the question-begging 
 reference to the law of the land. 
 
 IV. Dow v. Beidelman 
 
 In Dow v. Beidelman 1 the railroads again raised the 
 question of the constitutional limitation upon the rate- 
 making power of the State, in a suit to test the validity of 
 an Arkansas statute reducing passenger fares. The Court 
 quoted the dictum of the Commission Cases without com- 
 ment, but went on to add: 
 
 The plaintiffs in error . . . argue . . . that with the same traffic 
 that their road has now, and charging for transportation at the 
 rate of three cents per mile, the net yearly income will pay less 
 than If per cent on the original cost of the road, and only a little 
 more than 2 per cent on the amount of its bonded debt. But there 
 is no evidence whatever as to how much money the bonds cost, or 
 as to the amount of the capital stock of the corporation as reorgan- 
 ized, or as to the sum paid for the road by that corporation or its 
 trustees. It certainly cannot be presumed that the price paid at the 
 sale under the decree of foreclosure equaled the original cost of the 
 road, or the amount of outstanding bonded debt. Without any 
 proof of the sum invested by the reorganized corporation or its 
 trustees, the Court has no means, if it would under any circumstances 
 have the power, of determining that the rate of three cents a mile, fixed 
 by the legislature is unreasonable. Still less does it appear that there 
 has been any such confiscation as amounts to a taking of property 
 without due process of law. 
 
 1 125 U.S. 680, 8 Sup. Ct. 1028.
 
 52 FAIR VALUE 
 
 The attempt is made for the first time to indicate the 
 nature of the limitation on the State's rate-making power. 
 
 The value of the property is recognized as a feasible 
 basis for rate-making. The test of value suggested is the sum 
 actually invested. Capitalization and the value of outstand- 
 ing securities are rejected as a basis for valuation. But 
 the Court is still doubtful of its power to apply the test. 
 The dictum of the Commission Cases is not fully accepted. 
 The Court is unwilling to take a step which would in effect 
 change rate-making from a legislative to a judicial function. 
 The purpose of private property and the aims of regulation 
 have re-occurred to the judicial mind. The question of pub- 
 lic interest is still paramount, that of private property sub- 
 ordinate. 
 
 The issue arose next a few months later in the case of the 
 Georgia Railroad and Banking Company v. Smith, 1 in 
 which the roads again advanced the claim for exemption 
 based on a charter contract. The Court accepted and re- 
 stated the doctrine of the Commission Cases dictum with- 
 out analysis — quoting as its authority that case and Dow 
 v. Beidelman. 
 
 But here as in the Commission Cases the statement was 
 but dictum, as the only issue really before the Court was 
 the claim for exemption from all regulation by reason of the 
 alleged charter contract. 
 
 The Court shows the confusion and uncertainty under 
 which it labored by adding the apparently inconsistent but 
 judicially sound statement that: 
 
 When such use [publicl exists the business becomes subject to 
 legislative control in all respects necessary to protect the public 
 against danger, injustice, and oppression. 
 
 In Chicago, Milwaukee and St. Paul Railway Company 
 v. Minnesota 2 the question of judicial review was squarely 
 presented to the Court for the first time, but the case arose 
 
 1 128 U.S. 174, 9 Sup. Ct. 47, 32 L. ed. 377. 
 
 2 134 U.S. 418 and 458, 10 Sup. Ct. 462 (1st Minnesota Rate Case).
 
 VALUATION AND REGULATION 53 
 
 in a somewhat different manner from those previously con- 
 sidered. The State of Minnesota passed a law authorizing 
 the Railroad and Warehouse Commission to prescribe rea- 
 sonable rates. The State Supreme Court construed the act, 
 in spite of its apparently contrary intent, as conferring 
 final authority upon the Commission. And the Federal Su- 
 preme Court held this denial of judicial review a violation 
 of the due-process clause, saying: 
 
 The question of the reasonableness of a rate of charge for trans- 
 portation by a railroad company, involving, as it does, the ele- 
 ment of reasonableness both as regards the company and as re- 
 gards the public, is eminently a question for judicial investigation 
 requiring due process of law for its determination. ... If the 
 company is deprived of the power of charging reasonable rates for 
 the use of its property, and such deprivation takes place in the 
 absence of an investigation by judicial machinery, it is deprived of 
 the lawful use of its property, and thus, in substance and effect, of 
 the property itself, without due process of law, and in violation of 
 the Constitution of the United States, and in so far as it is thus 
 deprived, while other persons are permitted to receive reasonable 
 profits upon their invested capital, the company is deprived of the 
 equal protection of the laws. 
 
 The policy of judicial review was definitely accepted, 
 though not the basis upon which it rests. The dictum of the 
 Commission Cases became law without citation of authority 
 or statement of reason, and clearly without the formula- 
 tion of any definite basis upon which the review should be 
 conducted or any rules as to when it should be undertaken. 
 That portion of the decisions in the Granger Cases which 
 conferred power upon, or recognized authority in, the leg- 
 islature to regulate utilities and fix rates binding even 
 upon the courts was finally reversed. 
 
 The whole stress of the decision was placed upon the ab- 
 sence of notice and investigation in the rate-making, upon 
 the strict due-process clause as that term had been defined 
 up to this time. Due process still had not been authorita- 
 tively extended to include the requirement of just compen
 
 54 FAIR VALUE 
 
 sation when "taking private property for public use." The 
 basis of valuation was yet to be adopted. 
 
 The question arose next in Chicago and Grand Trunk 
 Railway Company v. Wellman, 1 and in Budd v. New York, 2 
 decided on the same day. In the latter case after reviewing 
 the entire field of decisions both federal and state the Court 
 concludes: 
 
 In the case before us, the records do not show that the charges 
 are unreasonable, or that property has been taken without due 
 process of law, or that there has been any denial of the equal pro- 
 tection of the laws; even if under any circumstances we could deter- 
 mine that the maximum rate fixed by the legislature was unreasonable. 
 
 Even yet the Court is feeling its way, is in fact doubtful 
 of its ability to question the reasonableness of the rate. 
 Corporation persistency has not succeeded in making regu- 
 lation and the public interest subordinate to the financial 
 interest of the investors. Regulation is still regarded as a 
 proper governmental function, to be exercised by the leg- 
 islature to any extent it deems necessary to further the 
 public welfare. Judicial legislation defining the status of pri- 
 vate property within the State is avoided. But there is con- 
 fusion in the decisions. No definite policy has been worked 
 out. The trouble-breeding dictum of the Commission Cases 
 is neither repudiated nor accepted. The decision in the 
 Granger Cases is neither reversed nor accepted in toto. The 
 Court see-saws first toward legislative regulation and pub- 
 lic welfare, then toward judicial interference and private 
 interest. 
 
 The facts in Budd v. New York differed from those in the 
 Minnesota Rate Case. In the former the rate-making power 
 was exercised directly by the legislature. In the latter it was 
 exercised by a commission. If the Court was willing to set 
 any limit at all on State rate-making along the lines indi- 
 cated in the first Minnesota Rate Case, it now indicated 
 
 1 143 U.S. 339, 12 Sup. Ct. 400. 2 143 U.S. 517, 12 Sup. Ct. 468.
 
 VALUATION AND REGULATION 55 
 
 that it was unwilling to extend that limitation to rates 
 directly fixed by the legislature. 
 
 Two years later the jumble left by the Budd decision was 
 cleared up to a large extent by the decision in the Reagan 
 Cases. 1 
 
 V. Reagan v. The Farmers' Loan and Trust Company 
 
 In Reagan v. The Farmers' Loan and Trust Company, 
 which rose by way of injunction issued to restrain the Texas 
 Railroad Commission from enforcing rates it had fixed, the 
 Court for the first time treats clearly the question of legis- 
 lative regulation of private property employed in a public 
 undertaking. After a review of the situation the decision 
 says: 
 
 These cases all support the proposition that while it is not the 
 province of courts to enter upon the merely administrative duty 
 of framing a tariff of rates for carriage, it is within the scope of 
 judicial power, and a part of judicial duty, to restrain anything 
 which, in the form of a regulation of rates, operates to deny to the 
 owners of property invested in the business of transportation that 
 equal protection which is the constitutional right of all owners of 
 other property. There is nothing new or strange in this. It has 
 always been a part of the judicial function to determine whether 
 the act of one party (whether that party be a single individual, an 
 organized body, or the public as a whole) operates to divest the 
 other party of any rights of person or property. In every constitu- 
 tion is the guaranty against the taking of private property for 
 public purposes without just compensation. The equal protection 
 of tbe laws, which, by the Fourteenth Amendment, no State can 
 deny to the individual, forbids legislation, in whatever form it may 
 be enacted, by which the property of one individual is, without 
 compensation, wrested from him for the benefit of another, or of 
 the public. 2 
 
 1 Reagan v. The Farmers' Loan & Trust Co., 154 U.S. 362, 14 Sup. Ct. 
 180, 38 L. ed. 1014; Reagan v. The Mercantile Trust Co., 154 U.S. 413; Rea- 
 gan v. The Mercantile Trust Co., 154 U.S. 418; Reagan v. The Farmers' 
 Loan & Trust Co., 154 U.S. 420. 
 
 2 See also Railway Co. v. Gill, 156 U.S. 649, 15 Sup. Ct. 484, 39 L. ed. 
 567. The rate question arose too in Covington & L. Turnpike Road Co. v.
 
 \ 
 
 56 1 FAIR VALUE 
 
 The Court does not question the legislature's right to 
 protect the public by fixing a maximum rate, but it reaffirms 
 without limitation the Court's right to review rates and 
 clearly establishes a minimum below which the legislature 
 cannot fix rates and enforce service. With equal clearness 
 the Court subordinates the utility's right to a profit to the 
 right of the public to receive service at reasonable rates, 
 saying: 
 
 It is unnecessary to decide, and we do not wish to be understood 
 as laying down an absolute rule, that in every case a failure to 
 produce some profit to those who have invested their money in 
 the building of a road is conclusive that the tariff is unjust and un- 
 reasonable. And yet justice demands that every one should re- 
 ceive some compensation for the use of his money or property if 
 it be possible, without prejudice to the rights of others. There 
 may be circumstances which would justify such a tariff; there 
 may have been extravagance and needless expenditures of money, 
 there may be waste in the management of the road; enormous 
 salaries; unjust discrimination as between individual shippers, 
 resulting in general loss. The construction may have been at a 
 time when material and labor were at the highest price, so that 
 the actual cost far exceeds the present value. The road may have 
 been unwisely built, in localities where there is not sufficient 
 business to sustain a road. Doubtless, too, there are many other 
 matters affecting the rights of the community in which the road 
 is built, as well as the rights of those who have built the road. 
 
 Value of the property is again recognized as a feasible 
 basis for rate regulation, and as in Dow v. Beidelman it is 
 the actual cost or investment which it is assumed will be 
 the controlling figure. In the principal case, however, a lim- 
 itation is placed upon actual cost. That limitation is refer- 
 ence to "present value," the concept which has brought 
 more confusion into valuation cases than all others com- 
 bined. And this limitation is imposed not to protect the util- 
 ity, but because actual cost may have been unjustifiably 
 high. 
 
 Sandford, 164 U.S. 578, 17 Sup. Ct. 198; and Chicago, B. & Q. R.R. Co. 
 v. Chicago, 166 U.S. 226, 17 Sup. Ct. 571, but no additional ruling of im- 
 portance was made.
 
 VALUATION AND REGULATION 57 
 
 The treatment of the problem is clear, but there is no 
 definite theory upon which the Court proceeds. Its state- 
 ments considered as independent, abstract legal proposi- 
 tions are indisputable, but considered as a whole they ap- 
 pear conflicting and ambiguous. The gist of the holding 
 seems to be that rates cannot be fixed at a figure which is 
 below the cost of production when proper methods are used 
 and only such investment is made as is necessary for the 
 service rendered. In other words, it is not the actual cost of 
 production, but the theoretical reasonable cost that is in 
 question. The Court for the first time places valuation on a 
 truly economic basis. The economies of monopoly are per- 
 mitted, but monopoly price is prohibited. The waste of 
 competition is banished, but its benefits arbitrarily re- 
 tained by fixing prices at approximately the cost of produc- 
 tion or competitive figure. The complete advantage of rate 
 regulation is gained by keeping the cost of production be- 
 low the competitive figure. The disadvantage of regulation 
 is eliminated by basing it on the same economic principle 
 which would have governed had natural competition ex- 
 isted. The public secures the advantage of lower rates, the 
 utility those from greater economy. 
 
 One point remains unsettled, i.e., the power of the State 
 to compel service at a rate below the cost of service. Where 
 that cost is greater than the theoretical or reasonable cost 
 the issue is decided in favor of the public. The case does not 
 involve a situation in which the worth of the service to the 
 community is less than the reasonable cost of service. 
 
 VI. The Growth of the Confiscation Analogy 
 
 The fallacy in the line of argument in the cases thus far 
 discussed first bore fruit in the Reagan Case where Jus- 
 tice Brewer intimated the propriety of reasoning in rate 
 cases by analogy with condemnation cases, saying: 
 
 If the State were to condemn the railroads, is there any doubt 
 that constitutional provisions would require the payment to the
 
 58 FAIR VALUE 
 
 corporation of just compensation, — that compensation being 
 the value of the property as it stood in the markets of the world 
 and not as prescribed by an act of the legislature? Is it any less a 
 departure from the obligations of justice to seek to take not the 
 title, but the use for the public benefit at less than its market 
 value? 
 
 In Ames. v. Union Pacific Railway Company x the anal- 
 ogy was stated again without, however, definitely holding 
 that the two situations were identical. 
 
 Such was the status of the law when the epoch-making 
 decision of Smyth v. Ames 2 was rendered. The power of the 
 State legislature to regulate was fully established, but 
 within certain limits only when the power was directed to- 
 ward rate-making. Rates could not be forced below a figure 
 which would render a fair return upon the "fair value" of 
 the property. What constituted a fair return or fair value 
 remained unsettled. The question of valuation had been 
 brought up in Covington and Lexington Turnpike Road v. 
 Sandford, indirectly in the Reagan Case, and had been 
 hinted at in Dow v. Beidelman, but it had not been defi- 
 nitely adopted by the Supreme Court. 
 
 The lower courts had discussed the question more thor- 
 oughly. In Ames v. Union Pacific Railway, 3 the Court 
 warned against unreasonable investment and suggested 
 the condemnation analogy. Two years later, in San Diego 
 Land and Town Company v. National City, 4 Judge Ross 
 
 1 64 Fed. 165. 
 
 2 169 U.S. 466. 18 Sup. Ct. 418, 42 L. ed. 819; Justice Brewer said: 
 "Property invested in railroads is as much protected from appropriation 
 as any other. If taken for public uses, its value must be paid for. Consti- 
 tutional guarantees to this extent are explicit. . . . The value of the prop- 
 erty cannot be destroyed by legislation. . . . The protection of property 
 implies the protection of its value. ... If the public was seeking to take 
 title to the railroad by condemnation, the present value is that which 
 it would have to pay. In like manner, it may be argued that, when the 
 legislature assumes the right to reduce rates, the rates so reduced cannot 
 be adjudged unreasonable if under them there is earned a fair interest on 
 the actual value of the property." 
 
 3 64 Fed. 165 (1894). 
 
 4 74 Fed. 79 (189G). See also San Diego Land & Town Co. v. Jasper, 110 
 Fed. 702 (1901) ; Cotting v. Kansas City Stock Yards Co., 82 Fed. 850.
 
 VALUATION AND REGULATION 59 
 
 held that as cost might be excessive, present value, deter- 
 mined with "due regard to the right of the public," must be 
 controlling. 
 
 VII. Smyth v. Ames 
 
 In Smyth v. Ames, 1 a suit brought to test the constitu- 
 tionality of the Nebraska maximum-rate law, the Court 
 finally definitely settled its right to test the reasonableness 
 of rate regulation, saying: 
 
 The idea that any legislature, State or Federal, can conclusively 
 determine for the people and for the courts that what it enacts in 
 the form of law, or what it authorizes its agents to do, is consist- 
 ent with the fundamental law, is in opposition to the theory of our 
 institutions. The duty rests upon all courts, Federal and State, 
 when their jurisdiction is properly invoked to see to it that no 
 right secured by the supreme law of the land is impaired or de- 
 stroyed by legislation. 
 
 The Court here defines its jurisdiction and for the first 
 time undertakes to state a basis for judicial review. The 
 Court is not concerned with rate-making as such, nor di- 
 rectly with reasonableness of rates. It is only the constitu- 
 tional guarantees which it must consider. It is only when a 
 rate violates one of these guarantees that it can be brought 
 before the Court. The expediency of the rate is not in issue. 
 The question is, Has the constitutional limitation been 
 violated? — not, Is the regulation reasonable? The former 
 is a judicial, the latter a legislative question. The two must 
 not be confused. The common-law limitation of reason- 
 ableness applies as a legal check upon rate-making by the 
 utility, but not upon rate-making by the State. 
 
 Failure to keep this distinction in mind and unwilling- 
 ness to admit that it has been made are responsible for 
 much of the confusion in valuation. Rate-making is a leg- 
 islative power. The question of reasonableness is a legisla- 
 tive one. The determination of what rights shall constitute 
 
 1 169 U.S. 466, 18 Sup. Ct. 418, 42 L. ed. 819.
 
 60 FAIR VALUE 
 
 private property at a given time is for the legislature. 1 But 
 the determination of what amounts to a taking of private 
 property for a public purpose, and what a restriction of 
 property without actual taking, is a judicial question. The 
 case leaves the opportunity still open for legislative dis- 
 cretion, and legislative action to protect the public welfare. 
 The Court next turns its attention to the purpose of reg- 
 ulation and decides beyond question that the protection of 
 the public interest is the paramount issue in rate regula- 
 tion, saying: 
 
 If a railroad corporation has bonded its property for an amount 
 that exceeds its fair value, or if its capitalization is largely ficti- 
 tious, it may not impose upon the public the burden of such in- 
 creased rates as may be required for the purpose of realizing prof- 
 its upon such excessive valuation or fictitious capitalization. . . . 
 What was said in Turnpike Co. v. Sandford, 164 U.S. 578, 596, is 
 pertinent. ... It cannot be said that a corporation is entitled as 
 of right, and without reference to the interests of the public, to 
 realize a given per cent upon its capital stock. When the question 
 arises whether the legislature has exceeded its constitutional 
 power in prescribing rates to be charged by a corporation control- 
 ling a public highway, stockholders are not the only persons whose 
 rights or interests are to be considered. The rights of the public are 
 not to be ignored. It is alleged here that the rates prescribed are un- 
 reasonable and unjust to the company and its stockholders. But 
 that involves an inquiry as to what is reasonable and just for the 
 public. . . . The public cannot be subjected to unreasonable rates in 
 order simply that stockholders may earn dividends. . . . If the cor- 
 poration cannot maintain such a highway and earn dividends for 
 stockholders, it is a misfortune for it and them which tlie Constitu- 
 tion does not require to be remedied by imposing unjust burdens 
 upon the public. 2 
 
 1 The legislature may limit the rights by destruction of unit rights 
 through the exercise of the State police power. 
 
 2 It was held in Chicago, etc., R.R. Co. v. Dey, 35 Fed. 866, that the in- 
 terest of mortgage bondholders is an element to be considered and that if 
 the rate fixed prevents interest being paid on the mortgage debt the en- 
 forcement of the schedule amounts to confiscation. It is suggested that the 
 mortgage-holder stands in no better position than the stockholder. He has 
 risktd his funds in the undertaking. If it was poorly conceived or badly
 
 VALUATION AND REGULATION 61 
 
 Having quoted with approval this decision that the in- 
 terests of the public are paramount to the property interest 
 of the utility the Court proceeds to point out which of those 
 property rights cannot be taken without compensation, 
 prefacing its remarks with a further guarantee of public 
 interest, thus: 
 
 It cannot be assumed that any railroad corporation, accepting 
 franchises, rights, and privileges at the hands of the public, ever 
 supposed that it acquired, or that it was intended to grant to it, 
 the power to construct and maintain a public highway simply for 
 its benefit, without regard to the rights of the public. But it is 
 equally true that the corporation performing such public serv- 
 ices, and the people financially interested in its business and 
 affairs, have rights that may not be invaded by legislative enact- 
 ment in disregard of the fundamental guaranties for the protec- 
 tion of property. The corporation may not be required to use its 
 property for the benefit of the public without receiving just com- 
 pensation for the services rendered by it. 
 
 The Court has set a minimum limit on rate-making — 
 the theoretical cost of producing the service plus a return. 
 The actual cost of production is immaterial. 
 
 The Court proceeds to define this minimum limit with 
 more exactness, thus: 
 
 The utmost that any corporation operating a public highway 
 can rightfully demand at the hands of the legislature, when exer- 
 cising its general powers, is that it receive what, under all the cir- 
 cumstances, is such compensation for the use of its property as 
 will be just both to it and to the public. 
 
 The market value of outstanding securities and the exist- 
 ing capitalization of the utility were rejected earlier in the 
 opinion, as unjust to the public. What would be just re- 
 mains undecided. 
 
 The contention of the State was that any legislative- 
 made rate schedule, providing necessary operating ex- 
 penses and a sum in addition thereto, would be reasonable, 
 
 managed, the consumer who exercised no judgment in making the invest- 
 ment cannot be required to make good the loss from the bondholder's own 
 folly.
 
 62 FAIR VALUE 
 
 the amount of the additional sum being purely a legislative 
 question not open to judicial review. The roads contended 
 that the schedule must provide a fair profit on the entire 
 capitalization, watered and real. The Court took a stand 
 midway between these views, saying: 
 
 We hold, however, that the basis of all calculations as to the 
 reasonableness of rates to be charged by a corporation maintain- 
 ing a highway under legislative sanction must be the fair value of 
 the property being used by it for the convenience of the public. 
 And in order to ascertain that value, the original cost of construc- 
 tion, the amount expended in permanent improvements, the 
 amount and market value of its bonds and stock, the present 
 as compared with the original cost of construction, the probable 
 earning capacity of the property under particular rates pre- 
 scribed by statute, and the sum required to meet operating ex- 
 penses, are all matters for consideration, and are to be given 
 such weight as may be just and right in each case. We do not 
 say that there may not be other matters to be regarded in estimat- 
 ing the value of the property. What the company is entitled to 
 ask is a fair return upon the value of that which it employs for the 
 public convenience. On the other hand, what the public is en- 
 titled to demand is that no more be exacted from it for the use 
 of a public highway than the services rendered by it are reason- 
 ably worth. 
 
 Thus the valuation test of the constitutionality of State 
 legislative rates, hinted at in previous decisions, is fully es- 
 tablished, by the Very justice who repudiated it in his dis- 
 senting opinion in the Commission Cases. 
 
 Valuation is accepted as a substitute for the analogy 
 with condemnation cases, which Justice Brewer suggested, 
 and to which Justice Harlan makes no reference. There is 
 no intimation that the valuation here suggested should be 
 the same as that in condemnation proceedings. The ele- 
 ments of value in that class of cases had been fully stated 
 by the courts. That Justice Harlan considered a definite 
 statement of the elements of value for rate-making pur- 
 poses necessary, and did not fashion that statement on con- 
 demnation lines, indicates that he did not consider the two
 
 VALUATION AND REGULATION 63 
 
 analogous. That he included in that statement elements 
 never considered as value in condemnation cases leaves 
 little room to doubt that the Court rejected the condem- 
 nation theory. 
 
 VIII. The Condemnation Theory 
 
 It may not be out of place to digress at this point and 
 consider that theory. It has acquired undeserved promi- 
 nence because it works emphatically to the benefit of the 
 utilities, and because writers on valuation have asserted 
 without careful analysis that the valuation test of the 
 reasonableness of rates had its origin in the condemnation 
 analogy. The analogy has never been definitely accepted by 
 the Supreme Court. The lower courts, however, have quali- 
 fiedly stated the relationship * in several cases, and fre- 
 quently considered the analogy without definitely stating 
 it. 2 But a preponderance of the decisions, even in the lower 
 courts, have flatly rejected the theory and clearly pointed 
 out inconsistencies in valuing public-service property for 
 rate purposes according to the standards set for condemna- 
 tion cases. 3 
 
 * In Spring Valley Water Co. v. City and County of San 
 Francisco, 4 the Court stated that: 
 
 1 Spring Valley Water Works v. San Francisco, 124 Fed. 574; Kings 
 County Lighting Co. v. Willcox, 156 App. Div. N.Y. 603; see also San 
 Diego Water Co. v. San Diego, 118 Cal. 556. 
 
 2 Oshkosh Water Works Co. v. Railroad Comm. of Wisconsin, 152 N. 
 W. 859; P.U.R. 1915-D-336; State ex rel. Oregon R. & Navigation Co. v. 
 Clausen, 116 PaciBc (Wash.) 7, dictum; State ex rel. Bee Building Co. v. 
 Savage, 65 Neb. 714, 91 N. W. (Neb.) 716, dictum; etc. 
 
 3 Pub. Serv. Gas Co. v. Bd. of Pub. Util. Commissioners, 87 Atl. 651 
 Re Manitowoc Water Works Co., 7 W.R.C.R. 71; Re Queens Borough 
 Gas & Elec. Co., 2 P.S.C. (1st. Dist.) N.Y.; Mayhew v. Kings County 
 Lighting Co., 2 P.S.C. (1st. Dist.) N.Y.; Spring Valley Water Works v. 
 San Franscisco, 192 Fed. 137; see also Willcox v. Consol. Gas Co., 212 U.S. 
 19, 29 Sup. Ct. 192, 53 L. ed. 382; Omaha Water Works Co. v. Omaha, 218 
 U.S. 180, 202, 54 L. ed. 991, 30 Sup. Ct. 615; Rept. of Nat'l Ass'n of Ry. 
 Commissioners, 23d Convention, Oct. 1911, p. 145; Rept. of Mass. Joint 
 Comm. on N.Y., N.H. & Hartford R.R. Co. 1911, pp. 51-154. 
 
 « 165 Fed. 667.
 
 64 FAIR VALUE 
 
 The idea that a valuable franchise could be taken in condemna- 
 tion proceedings, without compensation, would not be tolerated 
 for an instant and to permit such a franchise to be taken without 
 consideration indirectly, by means of rate regulation, is equally 
 obnoxious to the Federal Constitution. 
 
 The analogy was absurd, and the Supreme Court at ap- 
 proximately the same date refused to include any franchise 
 value other than such as had been established by statute. 1 
 It is by the recognition of elements of value in rate cases 
 which have no place in condemnation proceedings, and the 
 refusal to recognize elements which are essential to a valua- 
 tion for eminent-domain cases, that the fact is most clearly 
 brought out that no ground for analogy between the two 
 exists. 
 
 The analogy with condemnation cases has arisen in two 
 ways, by comparison of rate-making proceedings and con- 
 demnation cases, and by comparison of valuation for con- 
 demnation and for rate-making. The theory which supports 
 the analogy between the two types of proceedings is in- 
 herently unsound. Condemnation under the power of emi- 
 nent domain is the taking of private property for public use 
 on payment of due compensation. The payment of just 
 compensation whenever private property is taken is com- 
 pulsory under " the law of the land " and the Federal Con- 
 stitution. If the analogy holds true and a rate reduction 
 takes private property, there must be compensation pro- 
 portionate to the reduction. The vicious circle is encoun- 
 tered again. 
 
 A more logical explanation of the tangle is that the pub- 
 lic takes the use of utility property because of the common- 
 law requirement that all applicants must be served; and 
 that rate-making fixes the compensation for the taking. 
 Rates paying fairly for the use are legal; those returning 
 less are unconstitutional. The argument is false from the 
 
 1 Willcox v. Consolidated Gas Co., 212 U.S. 19, 29 Sup. Ct. 192, 53 L. 
 ed. 382.
 
 VALUATION AND REGULATION 65 
 
 economic viewpoint because the owner gets profit, not rent, 
 and it does not fit the legal situation. Jurists insist that reg- 
 ulation and rate-making are an exercise of the police power, 
 not of the power of eminent domain. And the police power 
 takes property without compensation. 
 
 It might be argued that the due-process clause applies to 
 the taking of profits rather than use, and that earnings 
 above a certain point are not private property and for that 
 reason can be taken with immunity by the public, but be- 
 low that point earnings are private property and cannot 
 be taken without compensation. Such reasoning would 
 comply with the social theory which holds all return above 
 a reasonable profit to be the property of the public. But so 
 long as the taking refers to earnings, the vicious circle re- 
 mains, for earnings are dependent upon rates. 
 
 There is only one solution of the situation created by 
 judicial interpretation. It is that what is taken is neither the 
 property, the use of the property, nor the profits. The serv- 
 ice and nothing but the service is taken. 1 So long as the 
 consumer pays the just rate for the service there is pur- 
 chase of service, but no taking by the State. The moment 
 the State prohibits the utility from collecting that rate, 
 there is a taking of service. The rate was fixed by the com- 
 mon law and the Constitution has not changed the limita- 
 tion. The criterion is the reasonable worth of the service 
 taken. 
 
 When the legislature fixes a rate below the point of rea- 
 sonable return, it is exercising its power of eminent domain, 
 by taking service in addition to that which the consumer 
 pays for, and the courts may intervene on the basis of fail- 
 ure to use due process of law by reason of the neglect to sup- 
 ply adequate compensation for the service taken. When the 
 
 1 The property may inadvisably be employed in producing a public serv- 
 ice under conditions which preclude a profit if the service is sold at its 
 reasonable value. In such cases rates which paid the full worth of the serv- 
 ice to the consumer would be constitutional, though no profit were pro- 
 vided.
 
 66 FAIR VALUE 
 
 legislature fixes a rate above that point, it is exercising its 
 rate-making power and the courts cannot interfere. The leg- 
 islature has at no time had any thought of condemning the 
 property, and no court has determined just compensation. 
 But these elements of the situation prove the failure to em- 
 ploy due process, rather than that the power of eminent 
 domain has not been exercised when the rate is unreasona- 
 bly low. 
 
 Two separate and distinct governmental powers are un- 
 der consideration, the police power and eminent domain. 
 The differences between them are many. In condemnation 
 cases the title to the property is taken, all use of the prop- 
 erty by the former owner is prevented, all elements of 
 value, in so far as he is concerned, are destroyed. In rate 
 cases not the title to the property, nor even the privilege 
 to use it in any certain manner is taken, but the privilege 
 of asking more than a certain return for the use of the prop- 
 erty in a certain manner is denied. No attempt is made to 
 compel such use. No force is employed to prevent other 
 uses. At most but a minor element of value is destroyed in 
 rate cases as opposed to all value in condemnation cases. 
 Rate-making, therefore, involves no payment of compensa- 
 tion for the value destroyed. It is destruction for the com- 
 mon good. It is not taking at all. The State receives nothing. 
 Nothing is to be paid for. The utility is merely prevented 
 from appropriating the public interest in profits for private 
 benefit, restrained from violating the common-law obliga- 
 tion of serving at a reasonable rate. Condemnation takes 
 value. The State receives value and must make payment 
 for it. 
 
 When a certain point has been reached the Court says : 
 thus far rate-making may go and no farther. If rates are 
 reduced lower, the utility will not be paid the worth of the 
 service. The State is no longer restraining private appro- 
 priation of public interest; it is appropriating private in- 
 terest. The difference between the rate the consumer says
 
 VALUATION AND REGULATION 67 
 
 and the reasonable rate is taken by the State for the public 
 welfare. If such taking is deemed necessary in the interest 
 of society, it must be accomplished through the power of 
 eminent domain and compensation must be made for the 
 loss. Rate-making is confined to the determination of the 
 fair return. 
 
 The law is interpreted to-day as it has just been stated. 
 It is illogical and confusing. It strains legal theory to the 
 breaking point. It is wholly out of accord with the funda- 
 mental concepts of the Nation's legal system. But it is 
 binding. It is the suspended axe under which legislatures 
 and commissions must exercise their rate-making powers. 
 Such an interpretation of the law is based upon the fun- 
 damental distinction between public utilities and other 
 industry, yet it absolutely ignores that distinction. This in- 
 consistency has bred the great majority of misunderstand- 
 ings that have blocked the successful application of the 
 valuation theory. 
 
 There is no possible application of the condemnation 
 analogy to property valuation for rate-making which is not 
 inconsistent with the fundamental principles of govern- 
 ment control and with the theory of private property it- 
 self. The value of the service which would be taken without 
 compensation if the unreasonable rates were enforced, is the 
 only value which is to be determined by condemnation 
 methods under the legal theory of rate-making. The value 
 of the physical property of the utility is not fixed for rate- 
 making upon that basis, for such property is not taken. 
 
 The conception of rate-making as a condemnation proc- 
 ess is a regrettable attempt to reinstate laissez-faire, indi- 
 vidualistic ideas and apply them to a legal and economic 
 situation wholly out of accord with those principles. The 
 result is that the courts and commissions have been forced 
 to disregard the makeshift doctrine at fully as many points 
 as they have been able to apply it. Inconsistencies, confu- 
 sion, and unsuccessful regulation have been inevitable, and
 
 68 FAIR VALUE 
 
 will remain so until the Supreme Court of the United States 
 summons up courage directly to reverse itself and disregard 
 the hybrid to which it has given birth. 
 
 A reversal of position as to the due-process clause in its 
 application to legislative action under the police power 
 would not necessarily carry with it a rejection of the valua- 
 tion doctrine. It would not lessen the protection afforded 
 private property, nor lower the return allowed for utility 
 service. The public utility has undertaken the conduct of a 
 governmental function for the benefit of the public, be- 
 cause the Government has deemed it expedient to have 
 that function performed by private individuals under 
 government control. A general public offer has been made 
 to induce capitalists to undertake this service. An implied 
 condition of that offer, absolutely essential to its success, is 
 that fair remuneration will be allowed for the service ren- 
 dered. It would be irrational to assume that the offer of the 
 State would be accepted by an individual unless it did con- 
 tain such provision. The privilege of collecting rates is given 
 to the utility as consideration for undertaking the service. 
 These rates are in reality taxes levied directly on those who 
 derive the benefit in much the same way as a special assess- 
 ment is apportioned. The acceptance of the offer constitutes 
 a binding contract between the State and the individual 
 undertaking the service. In undertaking the public service 
 the utility submits itself to the obligations imposed by the 
 common law. It assumes a heavy burden which carries with 
 it the implied right to collect a reasonable return for ren- 
 dering the service. The government, by compelling the com- 
 pany to serve all applicants and by accepting the service, 
 obligates itself to make reasonable payment for it. The con- 
 tract between the State and the utility, in the absence of a 
 specific provision to the contrary, raises an implied agree- 
 ment as to rates. The obligation of the contract cannot be 
 impaired by the State without violation of the Federal 
 Constitution. The consideration contemplated by the terms
 
 VALUATION AND REGULATION 69 
 
 of the implied agreement is paid, so long as the payment 
 vmade to the utility by way of rates collected for the ser- 
 ice rendered adequately compensates the utility operator; 
 and if the State does not prevent this by regulation it has 
 performed its part of the contract. The moment the State 
 reduces charges for service below the point of adequate 
 compensation, the rates become unreasonable, the contract 
 obligation is impaired, and the State has violated the pro- 
 visions of the Federal Constitution. The law fixing such a 
 rate is, therefore, unconstitutional. The result of such an 
 interpretation of the law gives to private property the same 
 protection that it enjoys under the condemnation theory, 
 so far as that theory can be put into practice at all. It is in 
 accord with the legal theories of American jurisprudence 
 and with the fundamental principles of private property 
 and government regulation. It does not strain legal theory 
 as the application of the condemnation analogy to the oper- 
 ation of the police power does. It unfortunately, however, 
 is not the interpretation adopted by the courts or that to 
 which valuation must conform. Its acceptance would clear 
 the confusion produced by the application of the individual- 
 istic theories to a quasi-public undertaking. But it has not 
 been accepted. A statement of it may assist the reader in 
 unraveling some of the tangled threads of the valuation 
 process, but it can be of no further service. 
 
 The argument that a valuation for rate-making pur- 
 poses should be computed upon the same basis as a valua- 
 tion for condemnation proceedings is as erroneous as the 
 application of the analogy to the exercise of the police 
 power. To view the question properly it is necessary, at 
 this point, to analyze the actual proceedings in rate cases. 
 A public-utility rate proceeding arises thus: 
 The legislature either directly, or by delegation of its 
 power to a commission created by it, fixes the rate which it 
 will permit the utility to charge. In doing this it exercises 
 an undisputed legislative function. One of the public utili-
 
 70 FAIR VALUE 
 
 ties subject to the schedule or rate thus fixed conceives the 
 idea that the rate is unreasonable. Its constitutionality is 
 attacked in the courts. Their sole duty is to decide the con- 
 stitutional issue — the constitutionality, not the reason- 
 ableness, of the rate is in question. 
 
 The complaint states that part of the bundle of rights 
 which constitute the private property employed in the util- 
 ity business has been taken by the public; that this taking 
 is such as can be accomplished only under the power of 
 eminent domain after just compensation; that the taking 
 has been attempted through the exercise, not of the power 
 of eminent domain, but of the police power, and is there- 
 fore without due process of law, and that as such taking is 
 confined to public utilities they are denied the equal pro- 
 tection of the laws, all in violation of the first section of the 
 Fourteenth Amendment to the Federal Constitution. 
 
 The right to make a return on the property is the only 
 right in the whole bundle affected, and it is affected only 
 to the extent of the difference between the rate fixed and 
 the reasonable rate. That part of that property right is in- 
 directly taken. The rights of possession, of disposal, and of 
 use are untouched. The condemnation theory of valuation 
 proceeds directly contrary to fact and considers all rights as 
 denied, for such is the case where the property is taken by 
 eminent-domain proceedings. When a water plant is con- 
 demned, the entire premises, the complete equipment, is 
 taken. Abandoned machinery still on the premises and 
 equipment far in excess of present needs, though neither 
 used nor useful for utility purposes, must be paid for as 
 part of the plant. In a rate valuation such property is not 
 included. Service is taken and the worth of the service must 
 be paid by way of compensation. Such property adds noth- 
 ing to the value of the service, so cannot be considered. The 
 right to a return is affected. And the owner has a right to a 
 return only on that part of the property that is actually 
 used and useful in rendering the public service.
 
 VALUATION AND REGULATION 71 
 
 Similarly lands and privileges granted to the utility by 
 the public have no place in a valuation for rate purposes, 
 for the property was donated to facilitate the public use, 
 not private gain, and the gift carried with it no right to a 
 return upon the property. The donee holds but the naked 
 title of a trustee, the return reverts to the public as cestui 
 que trust. Denial of a return on such property is restrictive 
 action under the police power in protection of the public's 
 interest, not a taking of private interest. 
 
 Advocates of the condemnation theory have been found, 
 however, who will sacrifice the part to save the remainder, 
 and claim that that which is taken can be valued by the 
 same process which is applied in condemnation cases. When 
 this stage is reached the value to the utility of the condem- 
 nation theory is practically destroyed, for its main objec- 
 tive is the saving to the utility of a rate of return on property 
 not properly included in a rate valuation. Even at this 
 point, however, the theory will not stand analysis. 
 
 Rate-making values property not to determine a price to 
 be paid for the property itself, but to fix the reasonable cost 
 of the service it helps to render. Condemnation proceedings 
 value property to estimate the reasonable price to be paid 
 for the property itself. The two cases cannot with fairness 
 be decided by the same standards. If a condemnation valua- 
 tion were adopted for both, the public interest would be 
 sacrificed in rate cases. If a rate valuation were adopted, the 
 utility's private rights would be violated in condemnation 
 cases. The reason back of the desire to carry the con- 
 demnation theory to rate cases is now apparent. There 
 remains to be considered the extent to which the courts 
 have been misled by insistent appeal to this analogy on 
 the part of counsel for the utilities. 
 
 IX. San Diego Land and Town Company v. National City 
 
 Reverting then to the consideration of the development 
 
 of the theory of valuation, we find that the questions pre-
 
 72 FAIR VALUE 
 
 sented in the case of Smyth v. Ames, last discussed, were 
 brought before the Court again the following year in the 
 case of the San Diego Land and Town Company v. National 
 City. 1 After reviewing Smyth v. Ames and Covington Road 
 Company v. Sandford, the Court adds to the test of rate 
 regulation set up in the former case the element of reason- 
 ableness to the public, protected fully in the earlier case, 
 but not definitely included in its enumerated items of the 
 elements of value. The Court said: 
 
 The contention of the appellant in the present case is that in 
 ascertaining what are just rates the Court should take into consid- 
 eration the cost of its plant; the cost per annum of operating the 
 plant, including interest paid on money borrowed, and reasonably 
 necessary to be used in constructing the same; the annual depre- 
 ciation of the plant from natural causes resulting from its use; 
 and a fair profit to the company over and above such charges for 
 its service in supplying the water to consumers, either by way of 
 interest on the money it has expended for the public use, or upon 
 some other fair and equitable basis. Undoubtedly all these mat- 
 ters ought to be taken into consideration, and such weight be given 
 them tohen rates are being fixed as under all the circumstances will be 
 just to the company and to the public. The basis of calculation sug- 
 gested by the appellant is, however, defective in not requiring the 
 real value of the property and the fair value in themselves of the 
 services rendered to be taken into consideration. What the com- 
 pany is entitled to demand, in order that it may have just compen- 
 sation, is a fair return upon the reasonable value of the property 
 at the time it is being used for the public. The property may have 
 cost more than it ought to have cost and its outstanding bonds 
 for money borrowed and which went into the plant may be in 
 excess of the real value of the property. 
 
 The new element to be considered is "the fair value in 
 themselves of the services." The value of the property can- 
 not determine the rate regardless of the value of the service 
 rendered. It is the theoretical or reasonable cost of serv- 
 ice which the court seeks to determine, not the actual cost. 
 
 The case brings out, too, the point that the enumeration 
 of elements of value in the Ames Case is not the establish- 
 1 174 U.S. 739, 19 Sup. Ct. 804, 43 L. ed. 1154.
 
 VALUATION AND REGULATION 73 
 
 ment of a rule of valuation. The elements set forth must be 
 considered in relation to the circumstances of the case. 
 Outstanding bonds may be disregarded where they repre- 
 sent no real value. Original cost must be restricted to rea- 
 sonable cost, etc. The elements stated in the Ames Case 
 may or may not be entitled to consideration depending 
 upon the particular circumstances in question. 
 
 X. Valuation as a Test for Individual Rates 
 
 Thus far the valuation theory has been applied to deter- 
 mine the reasonableness of entire rate schedules only. Its 
 applicability in cases involving a single rate is still to be 
 affirmed. That problem came before the Court in the case 
 of the Minneapolis and St. Louis Railroad Company v. 
 Minnesota, 1 wherein the Court held a rate on coal in car- 
 load lots reasonable and non-confiscatory, though if all 
 freight were subjected to a similar rate the road would not 
 be able to earn operating expenses. 
 
 In the case of the Northern Pacific Railway Company v. 
 North Dakota 2 the question arose again and the Court held 
 that the rate on coal could not be placed at so low a figure 
 that the carriage of the coal would not produce a reasonable 
 return in addition to operating expenses, etc., even though 
 the total return to the railroad from all traffic carried would 
 be adequate. The Minnesota Case was distinguished on the 
 ground that the rate on coal there established was not 
 shown to be an unreasonable rate for the coal traffic itself. 
 
 The valuation doctrine of the Ames Case is therefore to 
 be applied both to the return from any given rate and to the 
 return from the entire rate schedule. 
 
 XL The Recent Decisions 
 
 The recent decisions, with one exception, add nothing to 
 the fundamental valuation principles thus far developed. 
 They determine the propriety of including or excluding 
 1 186 U.S. 257. 2 236 U.S. 585, 59 L. ed. 735.
 
 74 FAIR VALUE 
 
 specific elements of value, or of arriving at fair value by 
 this or that method. 
 
 The exception is the decision in Knott v. The Chicago, 
 Burlington and Quincy Railroad Company, commonly 
 known as the Missouri Rate Case. 1 In this proceeding the 
 Supreme Court condemned valuation for rate purposes ar- 
 rived at by multiplying the tax assessment figures by three. 
 Aside from the statement that valuation for rate control 
 must be made with this purpose in view, which may be 
 radically different from that in other valuation proceedings, 
 the case adds nothing to those already discussed. 
 
 XII. Summary 
 
 The growth of the valuation theory has been gradual. 
 For a number of years after it was first suggested the courts 
 hesitated to interfere in rate-making lest they should as- 
 sume legislative functions. But the laws they were placed in 
 office to enforce, the Constitution, and the procedure, all 
 having been developed during the ascendency of the indi- 
 vidualistic laissez-faire epoch, sanctified private property 
 to such an extent that the Court found itself constrained to 
 intervene. Rate control through commissions was subjected 
 to the limitation of reasonableness. The check was vague. 
 The Court was feeling its way. Without defining the limit 
 the Court extended it to direct legislative rate-making. 
 Pressed by extreme adverse criticism and wholesale, un- 
 veiled charges of having resorted to judicial legislation in 
 the interest of wealth, the Court sought a basis for its in- 
 terference. The condemnation analogy, which likened val- 
 uation for determining the cost of service to valuation for 
 fixing a price on the property valued, was tested and dis- 
 carded. The analysis of the due-process clause which was 
 forced into prominence just at this time, by its reference 
 to the "law of the land," supplied the argument. 
 
 The police power is restrictive in its action. It may de- 
 1 230 U.S. 474, 33 Sup. Ct. 975.
 
 VALUATION AND REGULATION 75 
 
 stroy property to protect the public, but it cannot take it 
 for the public, without compensation. The law of the land 
 requires compensation when property is taken. The police 
 power, therefore, cannot be extended to the actual taking 
 of property. The courts were unwilling to consider rate- 
 making except as an exercise of the police power. They 
 declined to classify it as condemnation of the service. A 
 sort of hybrid theory of regulation resulted, which holds 
 that the State, in the exercise of its police power, may limit 
 the return to prevent the utility from appropriating the 
 interest of the public, but cannot take the service without 
 paying the utility what it is really worth. When such a 
 point in rate-making is reached the power of eminent do- 
 main, not the police power, is enforced, and the due process 
 required by the Fourteenth Amendment is lacking if com- 
 pensation is neglected. The equal protection of the law is 
 denied the utilities because other business is not subjected 
 to such confiscation. The right of the judiciary to intervene 
 and enforce the constitutional safeguards of property was 
 established. 
 
 The tests to be applied in that intervention were not de- 
 cided upon at first. Valuation had been suggested and re- 
 jected before the power to review rate-making was estab- 
 lished. The only form of valuation known was that applied 
 in condemnation cases. It did not fit the situation because 
 the value of the utility's property was sought to determine 
 the cost of the service, not to fix the price of the property. 
 The Court hesitated to adopt valuation, but finally took the 
 step. Having done so, it realized the opportunity for injury 
 to the public welfare which rate-making sought to protect 
 and hastened to place conditions upon valuation. Capital- 
 ization, the value of outstanding securities, the actual value 
 of the property, because they might be excessive and rep- 
 resent poor management or even fraud, could not be ac- 
 cepted as the criterion of value. Wear and tear on the equip- 
 ment required a reduction of value by way of depreciation.
 
 76 FAIR VALUE 
 
 In glaring generalities the situation was summed up by say- 
 ing that the utility was entitled to a "fair return" upon the 
 "present fair value" of the "property used and useful" in 
 rendering the public service, and the public was entitled to 
 service at a figure not above its actual worth. None of the 
 decisive terms were defined by the Court.
 
 CHAPTER IV 
 THE THEORY OF VALUATION 
 
 I. Valuation and Economics 
 
 The place of valuation in public-utility regulation is a 
 legal question, but the principles applied are economic. 
 Valuation, like any other legal action, may disregard eco- 
 nomic principles, but is bound to prove unjust and unsatis- 
 factory if it does so. The business world is controlled by 
 economic laws. Legislative or judicial action taken without 
 regard for those laws inevitably produces friction, economic 
 waste, and political dissatisfaction. 
 
 It is not difficult to learn the rules which form the law of 
 valuation, but that law is in an admittedly chaotic state, 
 and it avails little to segregate the authentic statements of 
 the courts from discarded principles and dicta. The deci- 
 sions have been stated chronologically to show how one was 
 built upon another to arrive at the final conglomerate struc- 
 ture. An attempt has been made to consider them and say 
 herein did the Court err or at this point legal requirement 
 departs from economic principles. But this is solely adverse 
 and destructive criticism. Constructive thought is needed. 
 Little aid can be derived from the knowledge that the law 
 is in conflict with economic rules if we do not learn the na- 
 ture of the conflict and determine how it can be avoided. It 
 is for this reason that we have braved the charge of irrele- 
 vancy and gone below the surface of valuation law to con- 
 sider the status of property and the general aims of regula- 
 tion before discussing the development of the valuation 
 principle or attempting to analyze it. 
 
 II. The Meaning of Value 
 
 The first problem in considering valuation is the defini- 
 tion of "value." It must be admitted at the start that the
 
 78 FAIR VALUE 
 
 term is used with widely varying meaning. Economists 
 have always recognized the vernacular use of the term and 
 the numerous resulting ideas of value, though Economics 
 itself has been almost exclusively concerned with "ex- 
 change value." Even the ancient thinkers recognized the 
 twofold division of value with which Adam Smith con- 
 fused economic thought for decades. 
 
 Value may be either subjective or objective. We may 
 speak of heat or light value as well as exchange value. 
 The term may be synonymous with utility. It may mean 
 abstract purchasing power, purchasing power measured 
 in commodities or in money, the average price, or the 
 "proper and legitimate price." 
 
 Professor Hadley has drawn a twofold division, even 
 within the field of economic value, which is of particular 
 interest here. He classifies value according to a com- 
 mercial and social theory closely allied to the dual nature 
 of property already considered. He says: 
 
 Value being essentially an ethical term, we may have as many 
 different theories of value as there are different views of business 
 ethics. But these views fall under two main heads : The commer- 
 cial or competitive theory which bases value upon what the buyer 
 is willing and able to offer for an article; and the socialistic theory 
 which bases it upon what the article has cost the seller in the way 
 of toil and sacrifice. 1 
 
 The loose usage of the term "value," antedating by cen- 
 turies the valuation doctrine, and the disagreement of econ- 
 omists even as to the fundamentals of economic value it- 
 self, should suggest the scholastic folly of the superficial 
 squabble over the propriety of using the term "valuation" 
 in utility regulation, which has marred much of valuation 
 literature. The term "fair value," however regrettable, has 
 been irrevocably incorporated in our vocabulary and must 
 be accepted. This being true, time can be spent with more 
 
 1 Hadley, Economics, sec. 105.
 
 [THE THEORY OF VALUATION] 79 
 
 profit in determining the meaning of the term than in ques- 
 tioning the judgment displayed in adopting it. 
 
 III. The Varying Uses of Valuation 
 
 The greater part of valuation literature has dealt with 
 the determination of fair value for rate-making purposes. 
 This, however, is but one of the many phases of the ques- 
 tion. Valuation is a part of the general regulatory pro- 
 gramme. It underlies almost every feature of regulation. 
 In addition to its place in rate-making, it serves as a basis 
 for control of capitalization to prevent stock-watering. It 
 fixes the foundation of security issues and enables the Gov- 
 ernment to protect the stockholder, the bondholder, and 
 the consumer from illegitimate financial practices. It forms 
 the basis upon which questions of purchase and sale are de- 
 cided, reorganizations and consolidations permitted, taxa- 
 tion levied, and private plants taken over by the Govern- 
 ment. 
 
 It requires little consideration of regulatory problems to 
 arrive at the conclusion that valuation for capitalization, 
 for purchase and sale, for rate-making, and for taxation 
 purposes cannot all be made upon the same basis. There 
 are as many forms of valuation as there are distinct phases 
 of regulation based upon property value. 1 
 
 1 Proceedings of National Ass'n of Ry. Commissioners, 1911, p. 145, 
 1913, p. 279; see also Report of Mass. Joint Comm. on N.Y., N.H. & 
 Hartford R.R. Co., Feb. 15, 1911, p. 55; In re Express Rates, Ind. 
 R.R. Comm. No. 495; "The fact that the State has taxed the company 
 upon its franchises at a greater value than is awarded them here is not ma- 
 terial," Willcox v. Consolidated Gas Co., 212 U.S. 19, 51, 29 Sup. Ct. 192; 
 53 L. ed. 382; Hill v. Antigo Water Co., 3 W.R.C.R. 623, 728; In re Mani- 
 towoc Water Works Co., 7 W.R.C.R. 71, 72; "Value is an elusive term, 
 and what may properly be a value for one purpose may be entirely im- 
 proper as a value for another purpose." In re Stockton Terminal (Cal.), 
 19 Am. T. & T. Co. Comm. Leaflets, p. 208; Furhmann v. Cataract Power 
 & Conduit Co., 3 P.S.C. (N.Y.) 2d Dist. 656, 691; Public Service Gas Co. 
 v. Bd. of Public Utility Comm. (N.J.) 87 Atl. 651, 658; etc. Contra. State 
 ex rel. Bee Bldg. Co. v. Savage, 65 Neb. 714, dictum; St. Louis & S.F.R. 
 Co. v. Hadley, 168 Fed. 317; etc.
 
 80 FAIR VALUE 
 
 In valuing a public utility for tax purposes it is immate- 
 rial to what use the property is put, or what return it pro- 
 duces. In valuing the same utility for rate-making the use 
 of the property becomes important and in fixing the sale 
 value the return may be considered. The purpose of valua- 
 tion is different in each case. In levying a tax the private 
 property of the utility stands in no different position from 
 other private wealth. The public interest in the use of the 
 property is not involved. In purchase-and-sale cases that 
 interest is in question only indirectly because the valua- 
 tion fixed may have a bearing upon future rate cases and 
 financial regulation. In rate cases the public interest is 
 predominant. 
 
 IV. Fair Value not Exchange Value 
 
 It is clear, since no one standard of value is applicable in 
 all cases, that "fair value" is not exchange value. 1 Valua- 
 tion for rate-making cannot be exchange value, for that it- 
 self depends upon rates and income, and rates and income 
 are the very things which valuation alters. The fair value 
 for rate-making must be determined before exchange value 
 can be found; therefore the two cannot possibly be identical. 
 The two values are antagonistic. It has been pointed out 
 that the purpose of regulation is to destroy value. Private 
 interest is wiped out as inconsistent with the public inter- 
 est. In determining commercial or exchange value the proc- 
 ess would be to ascertain the net earnings under present 
 rates, by deducting operating expenses, depreciation, and 
 taxes from gross revenue, and capitalize these, taking into 
 consideration appreciation of land and the value of property 
 not used in the public service. It is to avoid exactly this 
 valuation, rates based thereon, and the speculative element 
 
 1 See In re Westchester St. Ry. Co., wherein Chairman Stevens, of 
 the New York Second District Public Service Commission, attempts 
 to prove the contrary, and the dissenting opinion of Commissioner Sague. 
 3 N.Y.P.S.C. 2d Dist. 286.
 
 THE THEORY OF VALUATION 81 
 
 resulting therefrom that regulation exists. Fair value for 
 rate purposes, therefore, usually destroys existing exchange 
 value, and while it cannot be said to create a new exchange 
 value, it forms the basis upon which one will be created 
 whenever the occasion arises. 
 
 Rate-making value differs from exchange value in that 
 it deals only with property used and useful in rendering 
 the utility service, thus excluding many elements which 
 enhance the value of the property for exchange purposes. 
 Rate value cannot even be said to be the exchange value 
 of that portion of the property valued. 1 
 
 The reward for efficient management, which is a legiti- 
 mate element in exchange value, is excluded from valua- 
 tion for rate-making because that phase of regulation is 
 cared for by adjustment of the rate of return allowed on the 
 value ascertained. Going value as a separate element is sim- 
 ilarly denied, for aside from that part of such value recog- 
 nized either as development expense, the physical value of 
 services, etc., or reward for efficient management, it has no 
 place in the rate basis of a regulated monopoly. 
 
 V. Valuation for Rate-Making 
 
 The determination of fair value as an element of public- 
 utility regulation arose in rate cases. It bears the plain 
 stamp of its origin. Failure to realize this has bred confu- 
 sion. Rate valuation is distinctly different from all other 
 valuation. In rate-making the value sought is that socialis- 
 tic value based upon cost to the owner in the way of toil and 
 sacrifice, as stated by Professor Hadley. 2 It is in reality the 
 cost, not the value, of the utility property that is con- 
 
 1 R. L. Hale in his thesis on Valuation and Rate-Making, p. 37, suggest3 
 that the Court may have been attempting to determine the exchange ! 
 value of a part of the property, but having pointed out that such a theory 
 would permit only of rate regulation upward he concludes that: "It is not 
 entirely clear, however, that the Court meant by ' fair value ' the exchange 
 value of the physical property (plus the franchise)." Page 40. 
 
 2 Hadley, Economics, sec. 105, cited above, sec. II.
 
 82 FAIR VALUE 
 
 sidered. In purchase and sale, in taxation, in condemnation 
 in government-purchase cases, property value of one sort 
 or another is determined. But this is not true of rate 
 valuation in so far as property is concerned. The value of 
 the service is in question, but the cost and not the value 
 of the property is involved. 
 
 Valuation for rate-making purposes is a purely legal con- 
 cept. It is wholly distinct from economic valuation in gen- 
 eral. Economics recognizes two forms of valuation. Where 
 the object to be valued is freely reproducible, the reproduc- 
 tion cost determines the value. When the object is not freely 
 reproducible, because of monopolistic conditions, skill not 
 to be duplicated, etc., the economic value is determined by 
 capitalization of earnings. If economic value were sought, 
 public utilities would be valued by capitalizing earnings, 
 not because the utilities are monopolistic, or operate under 
 a franchise, but because of the skill, the risk, etc., entering 
 into their construction. It is, however, to avoid exactly this 
 valuation that regulation is undertaken. It is because any 
 substitute for competition would base rates on this valua- 
 tion that rate-making must be considered more than a 
 substitute for competition. 
 
 The public utility is not in the same category as other 
 industries. The capitalized earnings test cannot be applied 
 because it results in the vicious circle in the case of utilities. 
 The service rendered is governmental. Regulation is not 
 restricted to the prohibition of discrimination and refusal 
 to serve. It extends to rate control. The public has an inter- 
 est in the profits. The private property is altered by being 
 subjected to a serious encumbrance. It is absurd to argue 
 that the encumbrance does not change the value, or that 
 the public interest in profits requires a different form of 
 valuation. Economic valuation seeks market value and 
 market value cannot be determined until rate value is fixed. 
 A true understanding of "fair value for rate-making pur- 
 poses," as that phrase is now used, can be gained only when
 
 THE THEORY OF VALUATION 83 
 
 the distinct legal and economic status of private property 
 devoted to a public use is kept clearly in mind. The differ- 
 ence between the heavily encumbered value of private 
 property devoted to a public use, and the non-freely repro- 
 ducible industrial plant, is as great as the difference be- 
 tween such a plant and freely reproducible property. The 
 economic theory of valuation is applicable for regulatory 
 purpose only where the public interest in profits is not 
 involved and the market value of the property is sought. 
 The aim of rate regulation is to subordinate private gain 
 to public welfare; to prevent the utility from appropriating 
 that part of the profit which, because the business is gov- 
 ernmental, belongs to the public and must be given to them 
 by way of better service or lower rates; to reduce the ex- 
 change value of the private property constituting the util- 
 ity plant and equipment by reducing rates, below the figure 
 they would take in the absence of regulation, to a sum called 
 the reasonable rate. The legal rate is established primarily 
 to benefit the public; therefore, it cannot be above the com- 
 mercial value of the service. It must be, under a private- 
 ownership system, a rate which will attract capital, and not 
 amount to confiscation; therefore it cannot be below the 
 reasonable cost of production plus a fair return. Usually 
 there is no conflict between these limits. A rate to produce 
 a fair return to the utility need not be above the fair worth 
 of the service to the public, unless very poor judgment has 
 been displayed by the promoters. 1 
 
 1 The constitutional limitation merely states whether the rate can be 
 fixed under the police power or must be established by way of eminent do- 
 main with just compensation. There is no legal prohibition against forcing 
 rates below a remunerative point where conditions demand it. The primary 
 obstacle in such cases is the necessity of operating with private capital. 
 The commissions, however, have not hesitated to apply the limitation 
 based on the value of the service strictly when necessary. Commissioner 
 Shaw, of Illinois, deals with the situation in the Ardmore Water Case, 
 No. 4670, thus: Commissions and courts "have held that a rate for utility 
 service must be fair, alike to a utility and the public, but above all the rate 
 shall not exceed the value of the service rendered, regardless of losses which
 
 84 FAIR VALUE 
 
 It has been universally stated that the test of rate rea- 
 sonableness is dual, and that the two elements are wholly- 
 distinct, even antagonistic. It has been pointed out that if 
 the limit of a reasonable rate is the same by both tests, it 
 is but a coincidence; that there is far more likely to be a 
 zone between cost of service plus fair return and worth of 
 service, within which any rate fixed will be reasonable 
 tested by either criterion. Such discussion is needlessly con- 
 fusing. Under a system of private ownership the reasonable 
 cost of service and the worth of the service are normally 
 
 are to be suffered by a utility which may inadvisably have installed a 
 plant under and amidst adverse conditions [quoting from and citing Graf- 
 ton County Electric Light & Power Co. v. N. Hampshire; Campbell v. 
 Hood River Gas & Elec. Co.; Bogart v. Wisconsin Tel. Co.; In re Bound 
 Brook Water Co.; Oklahoma Gin Co. v. Oklahoma; In re Bridgeport 
 Natural Gas & Oil Co.; Geer v. Baltimore & O. R.R. Co.; In re Charles 
 Town Water Co. ; Butler v. Lewistown A. & W. St. Ry. Co. ; In re Colorado 
 Springs Light, Heat & Power Co.; Smyth v. Ames; Simpson v. Shepard], 
 although the petitioner herein has prayed that this commission fix water 
 rates for the village of Ardmore based upon a valuation of its properties, 
 such rates obviously would exceed the value of the service; and this com- 
 mission cannot find such rates to be reasonable in this particular case." 
 See also Brunswick & T. W. Dist. v. Maine Water Co., 99 Me. 371; "The 
 Public cannot be charged more than the service is worth, regardless of 
 whether the gross returns received from such rates give a fair return upon 
 the reasonable investment or not, for the public duty which the company 
 fundamentally owes its customers makes obligatory upon it the rendering 
 of service at fair rates for the service required regardless of any other con- 
 siderations," State ex rel. R.R. Comm. v. Seaboard Air Line Ry. Co., 48 
 Fla. 129, 37 So. 314. In the Minnesota Rate Case the Supreme Court of the 
 United States forced the railway to carry coal at a rate below the cost of 
 service, and in Cotting v. The Stock Yards a dictum recognizes worth of 
 the service as the supreme test of reasonableness. Interstate Commerce 
 Comm. v. Chicago, Gt. Western R.R. Co., 14 Fed. 1003; Planters' Com- 
 press Co. v. Chicago, C. C. & St. Louis R.R. Co., 11 I.C.C. 382; Planters' 
 Compress Co. v. Mo. K &T. R.R. Co., 11 I.C.C. 606; Memphis Cotton 
 Oil Co. v. Rlinois Central R.R. Co., 17 I.C.C. 313; National Hay Ass'n 
 v. Michigan C. R.R. Co., 19 I.C.C. 34; In re Advance on Coal to Lake 
 Ports, 22 I.C.C. 604; Coke Products Ass'n of Connellsville v. Baltimore 
 & O. R.R. Co., 27 I.C.C. 125; etc. There is, however, a line of cases repre- 
 sented by Clyde v. Richmond & D. R.R. Co., 57 Fed. 436, which hold that 
 worth of service cannot be considered, but these decisions are not in point, 
 for they discuss worth of the service to the individual consumer, not to the 
 public.
 
 THE THEORY OF VALUATION 85 
 
 identical, irrespective of how widely actual cost differs from 
 the worth of service. The only time the worth of the service 
 can fall below the cost, using the term "cost" as justifiable 
 or reasonable cost, is when a service is rendered in a com- 
 munity too small or too poor to afford such service. Private 
 ownership attempting to support itself on the return from 
 rates has no place under such circumstances. Government 
 ownership, subsidized private operation, or abandonment 
 of service is imperative. Where the conflict is apparent 
 rather than real, and results from poor judgment or bad 
 management, the situation can be remedied by compelling 
 the utility to make actual cost of service correspond to the 
 reasonable cost. 
 
 Value of service, being synonymous with reasonable cost 
 of service, may be disregarded without endangering the 
 public interest it protects. We are, therefore, concerned 
 solely with the determination of cost. But the cost we deal 
 with is the reasonable not the actual cost; otherwise the 
 value and cost of service are not equivalent and the former 
 must prevail, for it represents the social interest and is su- 
 perior to private rights which themselves exist only to pro- 
 mote the public welfare. 
 
 Under competitive conditions the rate tends to approx- 
 imate the cost of service. Capital flows freely into the util- 
 ity field at this figure. Regulation eliminates the risk due 
 to competition, and allows the savings available through 
 monopolistic production and rewards efficient manage- 
 ment. The utility can have no cause for complaint, there- 
 fore, when the rate-making body adopts cost of service as 
 the basis for charges. What constitutes "cost of service" is 
 the prime question. 
 
 Cost of service might be considered from either of two 
 angles, that of private interest and that of the public inter- 
 est. The former would be the proper viewpoint under the 
 laissez-faire system, upon which our economic theories are 
 almost wholly based. The latter is the only rational stand
 
 86 FAIR VALUE 
 
 when such a system has been abandoned and regulation in- 
 stituted. The fundamental economic rules cannot be dis- 
 regarded, but, on the other hand, economic principles based 
 upon a laissez-faire policy must be disregarded. The public 
 interest must predominate, for the private rights exist 
 only to promote the public welfare. We approach the cost 
 question, therefore, with an intent to promote the public 
 good, even at the expense of private rights. We recognize 
 but two limitations upon this purpose, that imposed by the 
 Fourteenth Amendment, which provides that beyond the 
 point at which rate-making takes instead of restrains, reg- 
 ulation must proceed under the power of eminent domain 
 instead of the police power; and that dictated by the neces- 
 sity of attracting capital or abandoning private opera- 
 tion. 
 
 So long as the State remains committed to private owner- 
 ship, it may well be considered estopped from asserting that 
 public interest extends further than the point which will 
 promote such a system. So long as private ownership is ac- 
 cepted, the State will be effectively prevented from assert- 
 ing a public interest which will preclude the steady flow of 
 capital into the utility field. The cost of service involved is, 
 therefore, one which will be fair to the investor. 
 
 The investor's chief interest is the securing of a steady 
 return upon his investment proportionate to the risk as- 
 sumed. The aim of regulation is to minimize that risk, thus 
 reducing the rate of return, and to see that only the actual 
 investment receives a return. "Valuation" is the determi- 
 nation of the amount of that part of the investment used 
 and useful in the service and represented by plant and 
 equipment. 
 
 Valuation for rate-making is a determination of invest- 
 ment, not of worth or value. It asks what sum did the in- 
 vestors put into the property; what did it cost them, not 
 what can they sell it for. The aim is to attract capital at the 
 lowest figure possible, and capital will be attracted as long
 
 THE THEORY OF VALUATION 87 
 
 as a fair return is allowed upon the actual present invest- 
 ment. 
 
 The utility company exercises a public function. It must 
 be satisfied with a limited return upon its investment and 
 must permit what would otherwise be the speculative prof- 
 its from the business to go to the general public by way of 
 reduced rates and better service. The interest of the public 
 in excess profits over a fair return is as absolute, under the 
 present legal system, as the property rights of the inves- 
 tors. Any method of final valuation which grants the utility 
 a return upon a larger sum than that actually invested takes 
 the property right of the public for the benefit of the utility 
 stockholder just as surely as unreasonable rate-making 
 takes utility property. 
 
 The private property voluntarily devoted to the public 
 use by the utility operator, in the eyes of the law, is in- 
 vested with the understanding that it is being subjected to 
 regulation. The restriction is stated in the common law. It 
 was stated when the utility company was organized and 
 was a part of the law, knowledge of which is required of all. 
 The investor or bondholder who disregarded the legal pro- 
 vision has only his own carelessness or gambling instinct to 
 blame when losses follow his laches. The fact that in reality 
 the investment may have been made with the knowledge 
 that an unreasonable return could be secured only gives in- 
 centive to enforce the strict legal rule with more rigor. The 
 law remains the same. Irrespective of what profit the com- 
 pany has actually made, all it was entitled to after under- 
 taking the public service was a reasonable return upon its 
 actual investment — not such return as it could secure in a 
 more hazardous business — not such return as it might gain 
 by putting its money out at interest, or by speculating in 
 real estate; but such return as it could reasonably exact 
 from the public for the utility service rendered. 
 
 Any form of final valuation not based directly upon the 
 actual reasonable present investment must inevitably fail
 
 88 FAIR VALUE 
 
 to meet the two principal requirements of regulation. It 
 cannot create a regulatory force which will keep rates near 
 the reasonable cost of production, and it will encourage 
 rather than stamp out speculation. 
 
 The aim of rate-making valuation is the determination of 
 the actual unimpaired investment reasonably necessary for 
 the utility service rendered. 
 
 VI. Valuation for Purchase and Sale 
 
 Valuation for purposes of purchase and sale differs es- 
 sentially from that for rate-making. 1 In determining a value 
 for rate-making purposes the public interest is directly and 
 vitally involved. Such valuation must be based directly 
 upon tangible or intangible property values contributing to 
 the public service. It must be an equitable figure as between 
 the public and the utility. Valuation for purchase and sale, 
 however, does not affect the public interest so vitally. The 
 chief concern of regulation in such cases is to make certain 
 that the property is not so crippled by indebtedness and 
 fixed charges as seriously to handicap service. The pur- 
 
 1 " In valuing utilities for the purpose of condemnation and purchase, 
 many elements must often be taken into account which should not be 
 given any consideration in valuations made for the purpose of rate-mak- 
 ing," Re Manitowoc Water Works Co., 7 W.R.C.R. 71, 72. See also Osh- 
 kosh Waterworks Co. v. Railroad Comm. (Wis. Sup. Ct.) P.U.R. 1915-D- 
 336; see Paper of Comm. Thelen before Nat. Ass'n of Ry. Commission- 
 ers, Oct. 30, 1913; Re Tyrone Electric Co. (111.) P.U.R. 1916-E-708; In 
 re Stark County Power Co. (111.) P.U.C. No. 6704, 6705; Re Crownover 
 Tel. Co. (Neb.) P.U.R. 1915-E-571; Commercial Club v. Missouri P. 
 Utilities Co. (Mo.) P.U.R. 1815-C-1017; Queens Borough Gas &Elec. Co., 
 2 P.S.C. 1st Dist. (N.Y.) 544; Mayhew v. King's County Lighting Co., 
 2 P.S.C. 1st Dist. (N.Y.) 659; Fuhrmann v. Cataract Power & Conduit 
 Co., 3 P.S.C. 2d Dist. (N.Y.) 656; Pub. Serv. Gas Co. v. Bd. of P. Util. 
 Comm'rs. (N.Y. Sup. Ct.) 87 Atl. 651; Willcox v. Consolidated Gas Co., 
 212 U.S. 19, 29 Sup. Ct. 192, 53 L. ed. 382; Omaha v. Omaha Water Co., 
 218 U.S. 180, 54 L. ed. 991, 30 Sup. Ct. 615; Ames v. Union Pacific Ry. Co., 
 64 Fed. 165; Spring Valley Water Works v. San Francisco, 192 Fed. 137; 
 etc. There were, however, early cases in which rate-making and purchase- 
 and-sale value were held identical. Spring Valley Water Works v. City of 
 San Francisco, 124 Fed. 574; etc.
 
 THE THEORY OF VALUATION 89 
 
 chaser and seller are the parties primarily concerned. The 
 seller is interested in securing the full value of his property, 
 on the basis of what it has been worth to him as an income 
 producer. He must base his price upon the revenues he has 
 received in the past and the outlook for the future. The pur- 
 chaser aims to pay no greater sum than he believes the 
 property will be worth to him as an income producer. He 
 bases his offer on the revenues receivable from the prop- 
 erty and his hope for developing the income in the future. 
 Both seller and purchaser are controlled by the physical 
 condition of the property and its effect upon future ex- 
 penditures for maintenance, and for additions and better- 
 ments. Both parties must be governed to a large extent 
 by the rate-making value of the property, since it limits 
 the future return. The price must be fixed at approxi- 
 mately the physical value of the property, for rate regula- 
 tion will prevent the earning of income on a value in excess 
 of that figure. 
 
 Conditions may exist, however, under which the pur- 
 chaser feels justified in paying an amount in excess of the 
 rate-making value of the property. The previous operation 
 of the property may have been so uneconomical as to leave 
 room for return from increased efficiency. There may be a 
 fair prospect of increasing net return by rendering a better 
 service at reduced rates, thus preventing public criticism of 
 rates until there has been time to recoup the difference 
 between the amount paid and the physical value of the 
 property. 1 
 
 The interest of the public in a purchase and sale case is 
 that rates shall not be made excessive to pay a return upon 
 a price above that of the rate-making value, that service 
 shall not be interfered with, and that the company shall 
 not be thrown into financial difficulties by reason of ex- 
 cessive capitalization on which only a small dividend may 
 be earned. The utility cannot, therefore, be allowed in a 
 1 See Re Stark County Tel. Co., 5 I.P.U.C. 63; etc.
 
 90 FAIR VALUE 
 
 purchase-and-sale case, to build up a capital account ma- 
 terially in excess of the rate-making value of the property, 
 or to issue securities in excess of that figure. Justice to the 
 stockholder demands that the capital be restricted to ap- 
 proximately the rate basis. Justice to the public demands 
 that the utility be placed on a sound financial basis. A pur- 
 chase-and-sale price may be authorized in excess of the 
 rate value of the property but the excess must be charged to 
 profit and loss or amortized from income. 
 
 VII. The Methods of Valuation 
 
 When valuation was first suggested as a test for the rea- 
 sonableness of rates, to determine when the exercise of the 
 State police power shaded off into the function of eminent 
 domain, the valuation suggested was the outstanding capi- 
 talization. This was natural because dividends were divided 
 upon the basis of capitalization and it was the dividend- 
 earning power which seemed to be in question. The utilities 
 favored such valuation because a majority of them were 
 capitalized in excess of actual investment and any other 
 basis would mean a reduced dividend. It was not, however, 
 a natural stand for the courts, even on an appeal for protec- 
 tion of property rights, and capitalization as a basis for 
 valuation has been consistently rejected from the start. 1 
 
 The market value of the outstanding securities was next 
 advocated, but was repudiated as a valuation basis for the 
 same reasons that discredited capitalization, i.e., neither 
 capital stock nor bonds necessarily represented moneys 
 actually invested or funds used in rendering the service, and 
 therefore could not be made the basis for determination of 
 the cost of service. The market value of securities is based 
 in part upon property not devoted to the public service and 
 other elements of value not admissible in a valuation for 
 
 1 169 U.S. 466; see argument of W. J. Bryan (p. 489) for the contention 
 of the carriers; Knoxville v. Knoxville Water Co., 212 U.S. 1; Cotting V. 
 Kansas City Stockyards Co.. 82 Fed. 850; etc.
 
 THE THEORY OF VALUATION 91 
 
 regulatory purposes. Market value, too, is based largely 
 upon return on the investment and thus upon rates. Rates 
 being the element involved the rate-making value would 
 have to be determined before the market value of the secu- 
 rities to make a reduction of rates possible — market value 
 involves existing rates — rate-making value is concerned 
 with reasonable rates. 
 
 The market value of the securities is an unacceptable 
 valuation basis, too, because it is readily susceptible to 
 manipulation. It is inherently unfitted for regulatory pur- 
 poses because it would prevent the elimination of specu- 
 lation. 
 
 The early decisions, realizing the defects of capitaliza- 
 tion and market value of securities, seemed to assume that 
 original cost must be accepted as the measure of value for 
 regulatory purposes. For this reason, they all sound a warn- 
 ing against confusing cost and book value. Original cost 
 must not be misdirected to include the fallacies of the dis- 
 carded theories. The public needs protection from a utility 
 which has become so powerful that regulation has been ren- 
 dered necessary. Original cost, or actual capital investment, 
 the Court hastens to point out, cannot be determined from 
 the books of the company alone. To base original cost solely 
 on book value would be to read into it all the fallacies of 
 valuation based on capitalization. It would permit the util- 
 ity company to direct its own regulation and wholly destroy 
 the value of government control. An estimate of the origi- 
 nal cost, the Court admits, however, may be made from the 
 company's records. The inventory may be based upon the 
 facts there shown. But the figures thus gained cannot be 
 accepted as the sole basis for a final valuation. Actual prac- 
 tice showed that the company's book entries of expendi- 
 tures must be checked to render the estimate allowed by 
 the Court a safe one for the public. To make such a check an 
 inventory of the property on some basis other than the 
 company's record was required. To verify that record with
 
 92 FAIR VALUE 
 
 current prices at the time of construction, to check back on 
 every stage of the company's development, seemed to ren- 
 der the check a more tedious and complicated process than 
 the inventory itself. A reproduction-cost appraisal was sug- 
 gested as a less troublesome check. 1 The courts accepted the 
 suggestion, and the new appraisal thus introduced has been 
 retained for other reasons. 
 
 Two forms of appraisal valuation have been developed, 
 original cost to date and reproduction cost. Detailed con- 
 sideration of their application is reserved for the following 
 chapter. 
 
 VIII. Summary 
 
 The conclusion naturally reached is that the term "fair 
 value, " if used without qualification as to its application, 
 is practically impossible of specific definition. Fair value for 
 rate-making purposes differs from that for purchase and 
 sale, and both differ from strict exchange value. No form of 
 value for regulatory purposes is the exact equivalent of 
 economic or exchange value. Value for condemnation pro- 
 ceedings is the nearest approach to that figure. Exchange 
 value considers only private interests. Regulatory valua- 
 tion involves the public interest. It is in the nature of an 
 accounting between the utility and the public and excludes 
 the public interest in the property which commercial or 
 economic value includes. Regulation limits or depreciates 
 exchange value. Valuation as a basis for purchase-and-sale 
 cases permits of the consideration of capitalized earnings, 
 and otherwise resembles exchange value, but it is mate- 
 rially restricted by the necessity of keeping the purchase 
 price near the fair value for rate-making. Rate valuation 
 exercises an indirect control over all other phases of regu- 
 lation. It is, therefore, the fair value for rate-making pur- 
 poses with which we are chiefly concerned. 
 
 The aim of rate regulation is to determine a rate base 
 1 See infra, Chapter V, Sec. III.
 
 THE THEORY OF VALUATION 93 
 
 which will permit the fixing of rates which will not exceed 
 the value of the service and yet be high enough to attract 
 private capital to the utility field and fall within the limita- 
 tion placed upon the police power by the due process clause 
 of the Fourteenth Amendment. The reasonable cost of the 
 service ordinarily affords such a base. Rate-making valua- 
 tion is a part of cost-of -service determination. It seeks to 
 establish the investment upon which a return must be 
 earned. It deals with investment and cost, not with value 
 as that term is commonly understood. It deals with normal 
 or reasonable, not actual investment. 
 
 Two principal methods of estimating reasonable invest- 
 ment have been developed. They are the original-cost and 
 the reproduction-cost appraisal. ,<
 
 CHAPTER V 
 VALUATION METHODS 
 
 I. The Inventory 
 
 It is the purpose of valuation to fix a basis for rate-mak- 
 ing, sale price, purchase price, taxation, reorganization, 
 and security issues — a basis which will protect the public 
 interest, induce capital to enter the utility field, and keep 
 regulation within the limits fixed by the Fourteenth 
 Amendment. How that basis is to be found remains to be 
 considered. 
 
 There are three distinct steps in valuation — the making 
 of the inventory, the determination of elements of value 
 properly considered in view of the specific purpose of the 
 appraisal, and the final determination of value. Much con- 
 fusion in valuation has resulted from unwillingness to recog- 
 nize this division. The engineer, all-sufficient unto himself, 
 selects the items he will emphasize, makes his inventory, 
 adds a finding of value, and submits the two as one, sup- 
 ported by a brief under the guise of a report. Writers dis- 
 cuss inventory, appraisal, and valuation as synonymous. 
 And the courts have fallen into the same error. 
 
 The first, and only the first, step is the sphere of the 
 engineer and accountant. The second step demands the 
 knowledge of the economist, and the third is the province 
 of commission and court. 
 
 The inventory lists in detail the tangible and intangible 
 property of the utility; the appraisal assigns a unit value to 
 each article listed. That value is determined by the theory 
 of appraisal irrespective of its effect upon the final valua- 
 tion or fair value for the specific purpose of the case. Next 
 the average life, age, and condition of each item is stated to 
 show the depreciated value. Here the appraisal technically 
 stops, but it is always accompanied by a history of the
 
 VALUATION METHODS 95 
 
 property. An accurate account of the organization, financ- 
 ing, and development of the corporation is essential to a 
 fair inventory of intangible property. 
 
 The total of the values shown by the inventory and ap- 
 praisal, irrespective of the theory of valuation used, does 
 not fix the value of the property, even though the property 
 be listed at its depreciated worth. The appraisal shows all 
 existing values regardless of their admissibility for rate or 
 sale purposes. It includes property not used or useful in 
 rendering the public service, expenditures injudiciously 
 made, and numerous other factors which cannot always be 
 considered in the final valuation. Its total is a figure which 
 may be just neither to the public nor to the company. 
 
 The appraisal is not concerned with fair value nor worth 
 of service. It is the engineer's or accountant's statement of 
 the exact present condition, character, and amount of the 
 tangible and intangible property, the actual or estimated 
 original or reproduction cost of each item thereof. It should 
 follow consistently the form of valuation selected, or draw 
 separate inventories upon each basis if more than one is 
 employed. It should represent the appraiser's best estimate 
 of the value of each item, without regard to the purpose of 
 the valuation. 
 
 The work of the economist begins when the appraisal is 
 completed. It is his duty to consider the items of value ap- 
 praised and determine which are to be considered for the 
 particular purposes of the proceeding. That decision, once 
 rendered, formulates a rule applicable in all similar cases. 
 Any element of value properly considered in one rate case 
 is relevant in any other, irrespective of whether it is allowed 
 as a part of the final valuation in the particular case. Any 
 element of value properly held irrelevant in one rate case 
 should not receive consideration in another. The statement 
 that "fair value cannot be found by formula" 1 refers ex- 
 
 1 Springfield v. Springfield G. & E. Co., I.P.U.C. No. 2138; Lincoln a 
 Lincoln Water & Light Co., I.P.U.C. No. 2496; P.U.R. 1917-B-l; In re 
 Berlin Elec. Light Co., 3 N.H. P.S.C. 174; etc.
 
 96 FAIR VALUE 
 
 clusively to the final valuation. It does not imply that fixed 
 rules cannot be formulated relative to the elements of value 
 properly considered or excluded for rate or sale purposes. 
 It merely means that these rules, though they determine 
 what general elements of value are relevant for each type of 
 valuation, do not assure such items of consideration in the 
 final valuation in each case. This is a limitation true of all 
 exclusion rules of evidence. It is true in valuation cases, be- 
 cause, for example, though engineering and legal expenses 
 are proper elements of value in the inventory, they may be 
 excluded from the final valuation because they were never 
 incurred, because improperly incurred or incorrectly in- 
 ventoried. Some elements of value, on the other hand, are 
 not properly considered in any rate case. Property not 
 used or useful in the public service, excessive franchise 
 values, etc., must always be excluded. 
 
 The determination of which of the elements inventoried 
 by the appraiser and branded admissible by economic rule 
 shall be taken into consideration in the particular case is 
 the work of the commission and court. That decision con- 
 stitutes the valuation of the property. 
 
 Valuation can be clearly understood only by considering 
 the two principal theories of valuation separately, and keep- 
 ing in mind that these theories are used in two wholly dis- 
 tinct and unconnected ways, (1) in the valuation of the 
 separate items of the inventory, (2) as the theory of final 
 valuation. In actual practice an appraisal based on only 
 one of these theories has seldom determined the final valua- 
 tion, unless the peculiar circumstances of the particular 
 case made such action unavoidable. The general rule has 
 been to accept appraisals based on original and reproduc- 
 tion cost respectively, made without regard to their effect 
 upon the final valuation; to determine from them the more 
 equitable cost under the circumstances, to eliminate the 
 elements of value not relevant in the special case, and then 
 depreciate the sum thus decided upon.
 
 VALUATION METHODS 97 
 
 II. The Original-Cost Theory 
 
 The first theory of value favorably considered by the 
 courts was the original cost of the property. Like most valu- 
 ation terms "original cost" has been employed with innu- 
 merable meanings, being twisted to suit the convenience of 
 the person making the appraisal, of the attorney, and un- 
 fortunately even of the courts. This jumbling of words has 
 resulted in the adoption of substitute terms and the draw- 
 ing of unnecessary technical distinctions. The confusion is 
 inexcusable, and bears every mark of a deliberate attempt 
 by designing utility representatives to render the original- 
 cost theory so indefinite and ambiguous that its applica- 
 tion must produce unreasonable results, and be frowned 
 upon by the courts. 1 
 
 Original cost, as a basis for final valuation, has been dis- 
 tinguished from both actual cost and book value. The three 
 terms would be synonymous under a proper system of ac- 
 counting. None of them are fitted to describe what original 
 cost means. Confusion has resulted, also, from the use of 
 the term to indicate either actual original investment alone, 
 or such investment plus betterments properly chargeable 
 to the capital account. 
 
 The narrow use of the term was forced upon the courts 
 by short-sighted public representatives in the early cases in 
 an attempt to exclude all betterments. The necessity of at- 
 tracting private capital for future improvements, and the 
 certainty of court intervention on constitutional grounds, 
 were overlooked. Utility attorneys, knowing that such an 
 interpretation would destroy original cost, readily assented 
 to it, and hastened to point out that, as thus used, it was an 
 improper basis even for an appraisal. 
 
 A careful consideration of the literature of valuation, the 
 
 1 This phase of the question is illustrated by the voluminous, and 
 ludicrous, if serious, brief filed for the carriers before the Interstate 
 Commerce Commission, August 1, 1917, in the valuation of the Texas 
 Midland R.R. Co.
 
 98 FAIR VALUE 
 
 briefs of attorneys, the reports of engineers, and court opin- 
 ions leads to the conclusion that original cost is now univer- 
 sally construed as original cost to date. It includes all ex- 
 penditures made in the original construction of the plant 
 and all additions and betterments chargeable to the capital 
 account under recognized accounting methods. It excludes 
 all expenditures for replacements made necessary by de- 
 preciation, obsolescence, or inadequacy. It corresponds to 
 neither actual cost nor book value. It is the original invest- 
 ment to date, using the word "original" to exclude re- 
 placements. 
 
 Any theory of original cost which failed to consider addi- 
 tions and betterments would render a valuation for rate- 
 making powerless to serve the purpose for which it was un- 
 dertaken. The rate-basis valuation is made to determine the 
 cost of service irrespective of its value. The valuation must 
 be fair to the public, but public interests are ordinarily pro- 
 tected by basing rates on reasonable cost of service, and 
 where such is not the case they must depend upon the 
 wholly distinct limitation, worth of service. If rates must 
 be fixed below the cost of service to keep them within the 
 value of the service, the action must be taken in spite of the 
 valuation, not by alteration of it. The questions valuation 
 deals with are, What is the investment upon which a return 
 must be allowed in order to attract capital? and, What is 
 the extent of the property rights protected by the Four- 
 teenth Amendment? The exclusion of expenditures for 
 reasonable additions and betterments would take private 
 property without compensation and drive capital from 
 the utility field. 
 
 The original cost to date indicates the property to be 
 included in the inventory and the unit value; but an ap- 
 praisal made on that basis does not necessarily represent 
 the final value of the property. The inventory may include 
 items not used or useful in the public service, improper 
 expenditures, etc., and irrespective of the appraisal basis
 
 VALUATION METHODS 99 
 
 the property must be depreciated to arrive at present 
 value. 1 
 
 The California Commission defines original cost as the 
 actual expenditures for operative property in cash or equiv- 
 alent in terms of cash, chargeable to capital in accordance 
 with the Interstate Commerce Commission's classification 
 as of the date of valuation. 2 
 
 The term is used by the Public Utilities Commission 
 of Illinois to mean the actual expenditures, in cash (or its 
 equivalent in terms of cash), made by the utility for used 
 and useful property which is properly chargeable to capital 
 account and which is embraced in an inventory; or, in the 
 absence of records and books of accounts showing the actual 
 expenditures, then, the estimated cost of the property as of 
 the sundry dates of the installations of the various property 
 items is considered the original cost thereof. 3 
 
 III. The Reproduction-Cost Theory 
 
 A second theory of valuation, reproduction cost, made 
 its appearance in the Supreme Court decision in Reagan v. 
 The Farmers' Loan and Trust Company, 4 where the Court 
 
 1 The term "original cost" has not been defined by the Federal Su- 
 preme Court and has seldom been explained by the lower courts. Com- 
 missioner Halford Erickson, of Wisconsin, in the Utilities Magazine, vol. i, 
 No. 3, p. 13, says: "By original cost in this connection it seems to me 
 should be understood the cost at which the existing property used by pub- 
 lic utilities in rendering service was acquired. By cost of reproduction is 
 meant the cost of reproducing the existing property under prevailing con- 
 ditions. The original cost of the existing property should be shown by the 
 books and records of the utilities providing these have been properly kept 
 and are still in existence. When the books have not been so kept or are not 
 available, the original cost as thus outlined may be determined very much 
 in the same manner as that in which the cost of reproduction is found." 
 Quoted with approval in City of Springfield v. Springfield Gas and Elec- 
 tric Co. (111.) P.U.R. 1916-C-281; and City of Lincoln v. Lincoln Water 
 and Light Co. (111.) P.U.R. 1917-B-l. 
 
 2 In re Sugar Pine R.R. Co. (Cal.) P.U.R. 1915-A-728; see also Annual 
 Rept. Cal. R.R. Comm. 1915-16. 
 
 3 Third Annual Rep. Illinois Public Utilities Comm., p. 93. 
 
 4 154. U.S. 362, 14 Sup. Ct. 180, 38 L. ed. 1014.
 
 100 FAIR VALUE 
 
 considered the showing that the railroad property under 
 consideration had cost $40,000,000 and could not be re- 
 placed for less than $25,000,000, and pointed out that be- 
 cause of extravagance, waste in management, enormous 
 salaries, and because "the construction may have been at a 
 time when material and labor were at the highest price, 
 'actual cost' may have exceeded the 'present value. ' " 
 
 The reference to reproduction cost in this decision and 
 "present cost of construction" in the Ames Case was seized 
 upon by utility attorneys and developed in this or that 
 direction as the advocate thought he could best serve his 
 client. The Court itself did not define the terms used. The 
 attempt to define them since have been many and varied. 
 They have developed along three general lines: (1) the cost 
 of reproducing a plant, similar in all essentials to the exist- 
 ing plant, under present conditions; (2) the cost of repro- 
 ducing a similar plant at present prices, under conditions 
 prevailing at the time of original construction; (3) the cost 
 of constructing a substitute plant capable of performing 
 the same service. "Cost of reproduction new less depreci- 
 ation," sometimes spoken of as a fourth form of the theory, 
 is but the application of depreciation rules to the in- 
 ventory. 
 
 IV. Development of the Reproduction Theory 
 
 The determination of what the term "reproduction 
 cost" means, requires consideration of the development of 
 the theory and an attempt to fix the weight of authority as 
 between the three forms advocated. 
 
 Following the decision in Smyth v. Ames there was a 
 marked lull in valuation. When the reproduction theory 
 reentered the arena in 1909, it came full grown, not the un- 
 defined infant suggested by Justice Harlan in 1898. The 
 theory had been developed outside the Supreme Court, 
 we may add, without its sanction. 
 
 Even prior to the memorable Ames Case the lower courts
 
 VALUATION METHODS 101 
 
 had dealt with the theory. In 1896 Judge Woolson, in the 
 case of Capital City Gaslight Company v. City of Des 
 Moines, 1 in determining the reasonableness of gas rates 
 based his estimate upon the estimated cost of an equally 
 efficient plant. In 1897 the Supreme Court of Minnesota, in 
 the case of Steenerson v. Great Northern Railway Com- 
 pany, 2 in considering the reasonableness of a rate reduction 
 made by the Minnesota Railroad and Warehouse Commis- 
 sion held that as values had declined reproduction cost, not 
 original cost, must control. 
 
 The case emphasizes the true origin of the theory. It was 
 founded in the over-zealous efforts of attorneys for the 
 State. It was forced upon the Court in an effort to lower 
 value. So far as the origin of the theory is concerned the 
 utilities have been guiltless. Their fault lies in their miscon- 
 struction and misapplication of the theory. 
 
 In 1902, in the case of Kennebec Water District v. City 
 of Water ville, 3 discussing a valuation for purchase purposes 
 not rate-making the Maine Supreme Court interpreted re- 
 production cost to mean the replacing of the present system 
 by one substantially like it, in its present condition and 
 with its present efficiency. Six years later the Federal Court 
 held, in Spring Valley Water Company v. San Francisco, 4 
 that the cost of a substitute system might be considered, 
 
 1 72 Fed. 829. 
 
 * 69 Minn. 353, 72 N.W. 713. The Court said: "Counsel for the railway 
 company dwell much upon the original cost. . . . No guaranty was ever 
 given by the State to the old road that the price of materials and the cost 
 of construction would not decline, or that capital invested in railroads 
 would not be subject to like vicissitudes as capital invested in other en- 
 terprises. Modern improvements and other causes have continued to re- 
 duce the cost of construction of all kinds of new plants, and to reduce the 
 value of old plants, or render them wholly worthless, and the State did not 
 guarantee that those causes should not in like manner affect the capital in- 
 vested in railroads. Then the material question is not what the railroad 
 cost originally, but what it would now cost to reproduce it." 
 
 1 97 Me. 185, 54 Atl. 6; see also Brunswick & T. Water District v. Maine 
 Water Co., 99 Me. 371 (1904). 
 
 4 165 Fed. 667.
 
 102 FAIR VALUE 
 
 but could not be made the controlling element in the valu- 
 ation. 
 
 In 1909 John W. Alvord stated his theory in detail 
 before the American Water Works Association. We feel 
 justified in quoting from it at length because it is largely 
 responsible for the utility concept of reproduction cost. His 
 statements were in part: 
 
 In estimating the cost of reproducing a plant it is obviously im- 
 portant to consider the reproduction as taking place in a way that 
 is humanly possible. Now it is not humanly possible to construct 
 a plant in the past, or in one day, or by the substitution of hind- 
 sight for foresight; therefore, if we are to avoid flights of construc- 
 tite fancy, we are compelled to consider the reproduction as tak- 
 ing place in the near future in reasonable and workable periods of 
 time, and without special foreknowledge other than that gained 
 from experience with similar construction and familiarity with 
 costs in the near past. To do other than this will not be "repro- 
 ducing." 
 
 A concept ional starting plant which is in process of being esti- 
 mated must be made to pass through all the preliminary phases of 
 mental origination as well as physical construction; it must con- 
 sider the time and cost necessary to devise, conceive, design, nego- 
 tiate, administer, and direct, as well as the labor cost of digging 
 and building, and the duplication which we try to imagine in- 
 volves the re-creation of many subordinate structures, appliances, 
 and much machinery which will have been removed or will have 
 ceased to exist. . . . 
 
 The conceptional starting plant must, of course, finally, pre- 
 cisely accord in form, dimension, and extent with the existing or 
 going plant. . . . 
 
 The . . . plant should . . . deal with all difficulties known to be 
 originally encountered in constructing the existing or going plant, 
 notwithstanding such difficulties might now be easily modified or 
 eliminated by a forewarned intelligence. 
 
 The value . . . should be computed upon such prices of labor and 
 material as it would seem safe for a prudent man to commit him- 
 self to and for such reasonable period in the near future, as expe- 
 rience shows will properly be required for construction. . . . 
 
 The method of valuing . . . will necessarily include all the ap- 
 preciations in value which logically and properly ought to be cred- 
 ited to the existing or going plant, by reason of its age. . . . 
 
 If appreciations are thus made necessary in the process of du-
 
 VALUATION METHODS 103 
 
 plication, it is also true that on the completion of the conceptional 
 starting plant, it must be reduced in value by the measure in which 
 the existing or going plant has depreciated through age, wear and 
 tear, by reason of new inventions, changes in demand, growth of 
 ideas, and other fluctuating conditions. The time element here is 
 of vital importance. 
 
 Mr. Alvord further explained his conception of the re- 
 production cost theory in a paper entitled, "Principles of 
 Public-Utility Valuation," read before a meeting of the 
 American Society of Civil Engineers, November 18, 1914, 
 thus: 
 
 . . . Having familiarized ourselves with the existing property 
 which is to be valued, we must in imagination, as a prolonged con- 
 ceptual process, retrace, step by step, every feature of the proce- 
 dure that would have to be taken if that property were completely 
 wiped out, and we were responsible for the task of entirely re- 
 building it in a reasonable length of time and in a manner which 
 is humanly possible. Should we unconsciously omit one impor- 
 tant step necessary to that rebuilding, we will fail to reach the full 
 cost. Being in possession of retrospect, we are constantly subject 
 to the temptation to substitute an easy and virtuous hindsight for 
 that real lack of foresight which would be our condition in actual 
 life and under ordinary conditions. If we do full justice to the pro- 
 cedure, we must trace two lines of human endeavor, that is, the 
 mental labor as well as the physical labor which produced the re- 
 sult before us. Mental endeavor will include the development of 
 the project and the preliminary steps of promotion. This must in- 
 clude the necessary time and pains that would naturally be taken 
 to see that the project is practical, the time and attention necessary 
 to negotiate the franchise, investigate the methods of service, and 
 estimate the preliminary work. We must at every step of the way 
 outline to ourselves the necessary lengths of interlapsing time to 
 do all these things, as well as the amount of labor to design, con- 
 tract for, and actually build each structure. Much of our cost will 
 be entirely dependent on the length of time we assume for these 
 practical operations. It is quite certain that the most trained 
 imagination, practically acquainted with similar construction, 
 will not always entirely succeed in redeveloping every detail in- 
 volving expense in such a procedure. . . .* 
 
 1 79 Trans. A.S.C.E. 144. Quoted as the basis of a valuation submitted 
 by Mr. Anderson in Lincoln v. Lincoln Water & Light Co., I.P.U.C. No. 
 2496.
 
 104 FAIR VALUE 
 
 These explanations of Mr. Alvord's theory fairly rep- 
 resent the reproduction method which the utilities, under 
 guise of compliance with Smyth v. Ames, have persistently 
 tried to make the predominant element in valuation, 1 and 
 which they now advocate before the Interstate Commerce 
 Commission under the Federal Valuation Act. 2 
 
 The reproduction theory of the utilities is one developed 
 from the versatile mind of well-paid utility advocates. It 
 has received consideration, but has not been generally ac- 
 cepted by regulatory bodies. How widely it differs from the 
 simple statement of Smyth v. Ames, that " present as com- 
 pared with original cost of construction" must be consid- 
 ered, is apparent at a glance. The words of the Ames Case 
 contain no command that the existing plant be theoretically 
 wiped from existence, or that the lessons learned in its con- 
 struction be forgotten. No direction is given that the plant 
 constructed in the present be identical with that in exist- 
 ence other than in the service it renders. On the contrary, 
 any rational construction of the term " present cost of con- 
 struction" would assume it to mean construction with pres- 
 
 1 Morris Knowles, "Relation of Reproduction Cost to Fair Value," 
 The Utilities Magazine, vol. I, no. 3, p. 17. 
 
 2 The synopsis of their brief filed preparatory to oral argument before 
 the Commission on September 30 and October 1 and 2, 1915, states their 
 theory thus: "In determining the cost of reproduction new, reference shall 
 be had to the conditions as they exist at valuation date, but the historical 
 construction of the property must be taken into consideration whenever 
 a rational engineering programme for reproduction would so warrant or 
 require. Conditions existing on the valuation date as to population, busi- 
 ness capacity, and productiveness and property values in the territory 
 served by the carrier are to be taken. The same quantities and classes 
 of grading materials which were originally obtained on the right of way 
 will be deemed to be obtainable in the same places, and the present cost 
 of moving the same will be ascertained. The cost of acquiring other nec- 
 essary materials from the most available sources on valuation date will 
 be ascertained. . . . The property of the carrier to be reproduced is to 
 be considered as non-existent. The general conditions outside of the right 
 of way and terminal lands of the carrier shall be considered to be as 
 of date of valuations." The same views are expressed in all the later 
 briefs.
 
 VALUATION METHODS 105 
 
 ent knowledge of facts and condition at present prices and 
 in accord with present standards. 
 
 Recognizing these facts the representatives of the public 
 have refused to accept the theory submitted by the utilities 
 and demanded that reproduction cost be figured on the 
 basis of a substitute plant capable of rendering substan- 
 tially similar service. 1 
 
 V. The Purpose of the Reproduction-Cost Appraisal 
 
 The aim of the substitute-plant theory is to give to the 
 public the advantage of savings from increased economy 
 under present knowledge and present conditions. Whether 
 or not the doctrine is justifiable depends upon what the ap- 
 praiser seeks to accomplish. The reproduction theory must 
 find its justification in the purposes of valuation. It must be 
 fair to the public and approximate the investment upon 
 which the utility is reasonably entitled to earn a return. It 
 must produce a figure which will attract capital without 
 being exorbitant. The nearer it comes to the actual justifi- 
 able capital investment the more fully it will promote the 
 aims of valuation. If the appraiser seeks to determine such 
 a value he must base his calculations upon the existing not 
 a substitute plant. If he views reproduction cost as a check 
 upon original cost, the substitute-plant idea must be dis- 
 carded for original cost values of the existing equipment. 
 If the appraiser conceives of reproduction cost as a curb 
 
 1 Whitten, Valuation of Public Service Corporation, p. 73, sec. 75; 
 Capital City Gaslight Co. v. City of Des Moines, 72 Fed. 829; Spring 
 Valley Water Co. v. San Francisco, 165 Fed. 667; Statement of C. L. Gorey 
 before the Pacific Coast Gas Association at its nineteenth annual meeting, 
 American Gas Light Journal, Oct. 23, 1911, p. 260. See also Murry v. Pub- 
 lic Utilities Comm., 150 Pac. 47 P.U.R. 1915-F-436, wherein the Idaho 
 Supreme Court said: "This court is of the opinion that the rule of cost of 
 reproduction less depreciation, adopted by the Commission, is the correct 
 general rule or principle to be applied in this class of cases. However, we 
 believe that in ascertaining values in this way the worth of a new plant of 
 equal capacity, efficiency, and durability, with proper discount for defects 
 in the old, and the actual depreciation for use, should be the measure of 
 value, rather than the cost of exact duplication."
 
 106 FAIR VALUE 
 
 upon the utility, allowing it to collect rates upon no greater 
 sum than the public would have to pay for a substitute 
 plant, the theory would be acceptable if the premises were 
 sound. But such an appraisal idea is not tenable. It confuses 
 value of property with value of service. It seeks to make the 
 appraisal perform the function of the final valuation. As a 
 basis for determining the worth of the service such a theory 
 would work admirably. It would conform more closely to 
 the true economic idea of price. But as a property-valua- 
 tion theory it is inexpedient. It injects into the attempt to 
 determine cost of service a wholly foreign element, value of 
 service. It works in the same vicious circle that market 
 value as a rate base does. It would nullify, to a large ex- 
 tent, the attempt to exclude speculation and put the utility 
 on a conservative business basis. It would force into the 
 business unreasonable risks necessitating a larger rate of 
 return and minimizing the possibility of regulating for the 
 general good. It would diminish the certainty and regu- 
 larity of income upon which the rate of return is fixed and 
 thus limit rate reduction. It would, in brief, inject into 
 the artificial economic system created for utilities a part of 
 the old economic rules discarded as inapplicable to such 
 undertakings. It would create a conglomerate regulatory 
 system one part of which was not in accord with the rest. 
 A compromise theory of reproduction cost has been de- 
 veloped with the evident thought of forcing the reproduc- 
 tion theory to approximate more closely the original or 
 actual cost basis upon which it operates as a check. 1 This 
 doctrine involves the reproduction of the identical prop- 
 
 1 Report of St. Louis Public Service Commission on Electric Light and 
 Power Rates, Feb. 17, 1911; Argument of H. P. Gillette before American 
 Society of Civil Engineers, 73 Transactions, A.S.C.E. p. 382; Lake Forest 
 v. Lake Forest Water Co., I.P.U.C. Nos. 2343 and 2275, P.U.R. 1915-D- 
 1008; Monahan v. Pacific Gas & Elec. Co. (Cal.) P.U.R. 1916-B-609; Re 
 Portland R. Light & Power Co. (Or.) P.U.R. 1916-D-976, where repro- 
 duction cost was limited to original investment and original cost applied 
 to betterments and additions.
 
 VALUATION METHODS 107 
 
 erty under original conditions, but at present prices. As 
 the theory differs from the present conception of original 
 cost only in that present, in place of original, prices are 
 used in the valuation, it needs little consideration. 
 
 A fourth theory of reproduction cost recently received 
 with favor by many of the commissions is based upon nor- 
 mal conditions and prices. It averages unit prices over a 
 period of years in the immediate past, and assumes normal 
 construction conditions. 1 It endeavors to eliminate those 
 elements of cost appearing in the strict reproduction esti- 
 mate which, because equipment was unsuited or prices 
 were abnormal, would cause the reproduction estimate to 
 reflect results either abnormally high or low. The normal 
 cost estimate is not governed by rigid adherence to the in- 
 ventory, though speculation and conjecture are not per- 
 mitted. Abnormal construction methods which might be 
 necessary in a strict reproduction estimate on account of 
 conditions which would not usually prevail are eliminated 
 in the normal cost estimate. It is based upon modern 
 equipment and present normal market, labor, and physical 
 conditions. It has the advantage of excluding unusual 
 prices, but increases rather than decreases the dependency 
 upon the individual judgment of the appraiser. 
 
 VI. Attempt to Discredit Original Cost 
 
 The utility companies early recognized that original cost 
 did not work to their advantage. It resembled publicity too 
 closely. It disclosed too many utility family skeletons. The 
 attention of the companies, therefore, was turned to re- 
 production cost. In it they readily recognized an opportu- 
 nity to turn defeat into victory. 
 
 A rigid campaign was instituted to discredit original cost. 
 The most vulnerable point of attack was the difficulty of 
 
 1 Piercy v. Citizens G., Elec. & H. Co. (111.) I.P.U.C. No. 4896, March 
 18, 1918. Normal cost has been accepted as an appraisal method and uni- 
 versally used in Illinois.
 
 108 FAIR VALUE 
 
 determining such cost. Propaganda pictured original cost as 
 wholly dependent upon a complete record of the utility's 
 growth with explicit entry of all purchases and expendi- 
 tures. The value of such reasoning was enhanced by the 
 fact that it lay within the power of the utility to multiply 
 the difficulty without serious danger of detection. Many 
 records probably had been lost or destroyed. Some com- 
 panies found it advantageous not to keep past records. Un- 
 doubtedly records were intentionally done away with. 
 There certainly was no vigorous effort made by many of the 
 companies to produce their books. 
 
 The difficulty of applying the original-cost theory seems 
 to have been systematically increased under advice of util- 
 ity attorneys, and has unquestionably been enormously 
 overestimated by them. 1 
 
 When any concerted attempt has been made to put 
 the theory into operation, no greater difficulty has been en- 
 countered than in applying the reproduction-cost method. 2 
 The cases in which commissions have found themselves 
 really unable to determine original cost, as the term is now 
 understood, have been, almost without exception, those in 
 which an original cost appraisal would have either produced 
 a final valuation much smaller than that shown by the 
 reproduction-cost appraisal, or disclosed facts which the 
 company would seriously object to proving against itself. 
 
 Mr. Halford Erickson, formerly of the Wisconsin Rail- 
 road Commission, contends 3 that "the original cost of the 
 
 1 Brief of C. E. Smith in Lincoln v. Lincoln Water & Light Co., I.P.U.C. 
 No. 2406, p. 65; Brief of Wilson, Warren & Child in Springfield v. Spring- 
 field G. & E. Co., I.P.U.C. No. 2138, p. 19; Argument of the carriers be- 
 fore the committee of the Senate considering the Federal Valuation bill. 
 See Senate Report No. 1290 of the 62d Congress, p. 54: Remarks of Presi- 
 dent Hadley before the Senate Committee; Report 3d Session 62d Con- 
 gress, p. 236; Marquis v. Polk County Tel. Co. (Neb.) P.U.R. 1915-C- 
 140; Remarks of C. A. Prouty before the Nat'l Ass'n of Ry. Commis- 
 sioners, Nov. 18, 1914. 
 
 2 See in re Central Pac. R.R. Co. (Cal.) P.U.R. 1916-B-845. 
 
 3 The Utilities Magazine, vol. I, no. 3, p. 113.
 
 VALUATION METHODS 109 
 
 existing property can be had with even greater accuracy 
 than the cost of reproduction." In Washington, where the 
 question was carefully considered by the State, the original 
 cost of all but five per cent of the entire railway mileage in 
 the State was obtained. 1 And a complete set of the original 
 contracts covering practically every mile of railroad com- 
 prising the Santa Fe System was admitted to be in existence 
 by the late Mr. Hurley, General Manager of that road. 2 
 
 The campaign to discredit original cost failed because the 
 propaganda could not obscure the fact that such valuation 
 is not dependent upon a complete record, but may be esti- 
 mated just as reproduction cost is calculated, and with as 
 great or even greater accuracy. Original cost can be figured 
 upon the same inventory as reproduction cost by merely 
 substituting prices of material and labor, which were cur- 
 rent at the time the items inventoried were put into the 
 plant, for the present or normal price used in the reproduc- 
 tion cost appraisal. The original prices may be secured in 
 part from the records of the firm and in part from the mar- 
 ket quotations of the period. 
 
 To bolster up their attacks the utilities sought to show 
 that by accepting reproduction cost as a check, the Court 
 was discrediting original cost and proclaiming the former 
 the principal basis of valuation. 
 
 The ludicrous argument constantly reappears in utility 
 briefs that the phrase, "the present as compared with the 
 original cost of construction," was adopted by the Court in 
 Smyth v. Ames in lieu of "the original cost of construction 
 compared with the cost of reproduction new," the innuendo 
 being that though the original-cost appraisal had been re- 
 tained for purposes of comparison, original-cost valuation 
 had been rejected in favor of a reproduction theory of val- 
 uation. 
 
 1 2d and 3d Annual Report, Washington R.R. Commission, p. 127. 
 
 2 Argument of A. E. Helm of Kansas Public Utilities Comm. before the 
 Interstate Commerce Comm. Jan. 26, 1916.
 
 110 FAIR VALUE 
 
 The language of the Court was : 
 
 We hold . . . that the basis . . . must be the fair value of the 
 property being used by it for the convenience of the public, and in 
 order to ascertain that value, the original cost of construction, the 
 amount expended in permanent improvements, the amount and 
 market value of its bonds and stocks, the present as compared with 
 the original cost of construction. 
 
 The terms used by the Court here seem unusually clear. 
 Fair value is to be determined. It is neither original cost nor 
 reproduction cost; both must be considered. The original 
 cost of construction to date must be ascertained, the amount 
 and value of outstanding securities determined, and the 
 present cost of construction estimated. From all these and 
 perhaps many more elements fair value is to be fixed. 
 
 The instruction thus given, though far from being as ex- 
 plicit as could be desired, has been literally followed by 
 most of the courts and commissions. 1 The final valuations 
 reached in a few decisions have been based almost entirely 
 upon original cost. 2 Other cases deviating in the opposite 
 direction have seemed to consider only reproduction cost 
 in reaching the final valuation. 3 No court, however, it is be- 
 
 1 Western Advance Rate Case 20, 1.C.C. S07; In re Berlin El. Light Co. 
 3 N.H. P.S.C. 174; Springfield v. Springfield Gas & Elec. Co., I.P.U.C. No. 
 2138; Lincoln v. Lincoln Water and Light Co., I.P.U.C. No. 2496; Buffalo 
 Gas Co. v. Buffalo, 3 P.S.C. 2d Dist. (N.Y.) 553; Commercial Club v. Citi- 
 zens Gas & L. Co. (Ind.) P.U.R. 1916-E-l; Bogart v. Wisconsin Tel. Co. 
 (Wis.) P.U.R. 1916-C-1020; Re Dunham (Mo.) P.U.R. 1916-E-544; etc. 
 See also Ames v. Union Pacific Railway Co., 64 Fed. 165; Appleton v. 
 Appleton Water Works Co., 5 W.R.C.R. 215; Report of St. Louis Public 
 Service Commission on United Railway Company, 1912. 
 
 2 San Diego Water Co. v. San Diego, 118 Cal. 556, 50 Pac. 633; Re 
 Cripple Creek Water Co. (Cal.) P.U.R. 1916-C-788; Public Service Comm. 
 v. Pacific Tel. & Telg. Co. (Wash.) P.U.R. 1916-D-947; Butler v. Lewis- 
 ton A. & SW. St. R.R. Co. (Mo.) P.U.R. 1916-D-25; etc. See also Re- 
 port of St. Louis Public Service Comm. on Southwestern Tel. & Telg. Co. 
 1913, Pub. Serv. Comm. of New Hampshire, 1912, p. 302. 
 
 » Re San Jos6 Water Co. (Cal.) P.U.R. 1915-E-706; Re Terminal Taxi- 
 cab Co. (D.C.) P.U.R. 1915-B-546; In re Bronx Gas & Elec. Co. (N.Y.) 
 P.U.R. 1916-A-440;Steenerson ©.Great Northern Ry. Co., 69 Minn. 353, 
 72 N.W. 713; Shepard v. Northern Pacific Ry. Co., 184 Fed. 765. (Re-
 
 VALUATION METHODS 111 
 
 lieved has taken the definite stand that an inventory based 
 on the cost of reproduction is to be accepted as the sole 
 guide in valuation for rate-making purposes. 
 
 The argument upon which the contention for reproduc- 
 tion cost as the sole basis of final valuation is founded, has 
 been clearly stated in one or two of the lower court cases. 
 Judge Hough, in Consolidated Gas Company #. Willcox, 1 
 said: 
 
 It is impossible to observe this continued use of the present 
 tense in these decisions of the highest court without feeling that 
 the actual or reproductive value at the time of inquiry is the first 
 and most important figure to be ascertained. 
 
 And in Louisville and Nashville R.R. Co. v. Railroad Com- 
 mission, 2 it was said: 
 
 And in every case, after finding the original cost, when possible 
 to be done, the question would still have to be solved as to whether 
 such original cost is the same as the present value, which would in- 
 volve the determination of the present value for such comparison 
 independent of original cost, and in no other or better way than 
 on reproduction values. 
 
 The fundamental thought is that present value must 
 mean reproduction cost. The argument is unsound. It begs 
 the question. It assumes that reproduction cost and present 
 value coincide, and using that assumption (which is the 
 very point to be proved) as a major premise the argument 
 proceeds to the conclusion it assumed at the start. The ar- 
 gument may be stated thus: "All present value is deter- 
 mined by reproduction cost. The Supreme Court has said 
 we must determine present value. Therefore, we must de- 
 termine reproduction cost." 
 
 A very meager consideration of the Supreme Court cases 
 demonstrates that no such general proposition as has been 
 assumed can be gleaned from them. On the contrary, they 
 
 versed on this point by the Federal Supreme Court in the Minnesota 
 Rate Cases.) 
 1 157 Fed. 854. * 196 Fed. 800.
 
 112 FAIR VALUE 
 
 have held distinctly that reproduction cost and present 
 value are not synonymous terms. 
 
 The unmistakable trend of the decisions since 1914 has 
 been away from accepting any theory of reproduction cost 
 as a sole or predominant element in valuation and toward 
 recognizing it as a check upon and supplement to original 
 or actual cost. An attempt is undeniably being made to 
 meet the utility suggestion of reproduction cost as the prin- 
 cipal or sole basis for final valuation, by forcing that theory 
 of valuation into the background and relying almost wholly 
 upon actual investment. 
 
 VII. Dejects of Strained Reproduction Cost 
 
 The chief objection to the reproduction theory, from the 
 public standpoint, is that a valuation based thereon inva- 
 riably carries conjectural charges for overhead expenses in 
 excess of those actually paid and thus capitalizes against 
 the public sums which were never expended, from which 
 the public has derived no benefit, and which cannot be said 
 to add to the value of the plant, regardless of the theory of 
 appraisal adopted. 1 
 
 The reproduction theory under the constantly rising 
 costs capitalizes wages and cost of material at prices far 
 above those actually paid, and gives a return to the stock- 
 holder at the expense of the public on an imaginary invest- 
 ment which he never made. It values visionary capital 
 which has in no way added to the business or made it better 
 fitted to serve the public. 
 
 The same criticism applies to the inclusion in the re- 
 production-cost inventory of the theoretical cost of cutting 
 
 1 Lincoln v. Lincoln W. & L. Co., (HI.) P.U.R. 1917-B-l. See also Spring- 
 field v. Springfield G. & E. Co. (111.) P.U.R. 1916-C-281. " It is an amusing, 
 although regrettable, commentary on the imperfection of regulation, to 
 note that the fair value rule, controlled by the cost of reproduction less 
 depreciation method is to-day perpetrating the identical evils which its 
 creation was designed to prevent." Re Indianapolis Water Co. (Ind.) 
 P.U.R. 1919-A-448, 465.
 
 VALUATION METHODS 113 
 
 pavements, which in reality were laid long after the con- 
 duits were placed, and which never have been cut, and if 
 cut in the future will be paid for from sources other than the 
 capital account. The capitalization of land values never 
 paid by the investors and which never will have to be paid 
 is another disputed phase of the reproduction theory. It 
 produces a fictitious property interest not protected by the 
 due-process clause because it does not contribute to the use 
 taken. It is in short but a skillfully disguised stock-watering 
 scheme. Honestly made and carefully used, however, the 
 modified reproduction-cost appraisal is an aid in determin- 
 ing final value. 
 
 Most of these defects which make the reproduction-cost 
 theory unavailable as a sole basis for valuation are treated 
 in detail in later chapters. 
 
 VIII. The Actual-Investment Theory 
 
 The realization of the undesirable results attending the 
 application of the reproduction-cost theory to rate-making 
 valuation has done much to encourage an attempt to de- 
 termine the true basis of valuation. It is difficult to un- 
 derstand the influence the reproduction theory exerted on 
 courts and commissions unless it be attributed to the pro- 
 verbial inability of lawyers to grasp accounting theories. 
 Rate valuation is but one step in cost accounting. It cor- 
 responds to the factory inventory. Reasonableness of rates 
 is the issue. Cost of producing the service is the basis for 
 deciding that issue. The principles involved in this cost- 
 finding differ in no material aspect from those involved in 
 the determination of costs in the general industrial world. 
 Investment, or original cost, has always been the basis of in- 
 dustrial cost-finding. 1 
 
 1 " The thing that is of importance for the business is what its equip- 
 ment actually cost, not what such equipment would have cost under 
 other conditions. If actual costs are recorded, with the date of occur- 
 rence, the cost of duplication can always be figured by a comparison 
 of prices paid with current prices; so the argument for keeping cost of
 
 114 FAIR VALUE 
 
 The process is most aptly stated by Professor W. M. 
 Cole l thus: 
 
 If we wish to know the justice of the dividends of a corporation, 
 what do we need to know? Three things: what the investors have 
 put in; what risks they have taken; what they have taken out. 
 Nothing else can be of any importance in settling our question. 
 
 In regulation, valuation seeks to determine the first of these 
 elements, the rate of return considers the second, and from 
 these two the proper third is fixed. The sole difference be- 
 tween cost-finding in regulation and in the factory is that 
 rates are based upon reasonable costs in one and actual 
 costs in the other. 
 
 The "reproduction-cost-new" theory of appraisal has no 
 place in a cost system, when actual cost figures are available. 
 It is of value when original cost cannot be readily ascer- 
 tained; but the value it possesses is a reflected one. Repro- 
 duction cost itself is not an element in any cost of produc- 
 tion figure. Its only possible use is as a basis for estimating 
 actual cost. The rate-making valuation must be based upon 
 the actual, reasonable cost or the most accurate estimate of 
 that cost. Realization of this fact has forced the reproduc- 
 tion theory into the background in rate cases. 
 
 The movement favoring actual investment was given 
 momentum by the discovery that under the strained con- 
 structions placed upon the reproduction theory by utility 
 representatives that theory was becoming a most serious 
 menace. Under the sanction of the courts, utilities were 
 seeking over-capitalized values beyond the dream of the 
 most ardent promoters. 
 
 One stronghold after another of the utility-made repro- 
 duction theory was attacked and successfully carried. The 
 
 duplication on the books entirely disappears ... to register on the 
 books a capitalization based on earning capacity is not only to register 
 an unnecessary figure but to bury the actual cost of the assets. . . . 
 To summarize, no theoretical accounting aims support any view of capi- 
 talization other than cost." Cole, Accounts; Their Construction and Inter' 
 pretation, p. 163. 
 
 1 Accounts; Their Construction and Interpretation, p. 168.
 
 VALUATION METHODS 115 
 
 elimination of cost of paving not actually cut, the adoption 
 of rational methods in the determination of land values, 
 the consideration of piecemeal construction, the use of 
 average unit prices, the adoption of reconstruction under 
 original conditions, the refusal to allow going value as a 
 separate element, all mark stages in the revolt against over- 
 capitalization by way of reproduction cost. 
 
 The attitude of the commissions and courts to-day is 
 stated in the decision in Grafton County Electric Light and 
 Power Company l that a fair return on the outlay actually 
 made by the utility for the public service, assuming rea- 
 
 1 28 A. T. & T. Co., Commission Leaflets, 533. See also Berlin Electric 
 Light Co., 3 N.H. P.S.C. 174, 21 A.T. & T. Co. Comm. L. 781. "The the- 
 ory [reproduction cost] at first thought in all cases is plausible and attrac- 
 tive, but in the end oftentimes utterly illogical and unreliable, originally 
 adopted as a mere time-saver by mere theorists, and sought to be enforced 
 as against substantial and unbending facts," Des Moines Gas Co. v. Des 
 Moines, 199 Fed. 204, 207. The general instability of the reproduction-new 
 theory was realized and understood by prominent proponents of the Fed- 
 eral Valuation Act. Senators Bristow of Kansas and La Follette of Wis- 
 consin, on February 24, 1913, participated in the following colloquy: "Mr. 
 Bristow: 'There is one point I wanted to bring out with regard to that 
 feature of the bill that requires the Commission to ascertain the cost of 
 production new. Such a finding, in my opinion, is not of any great value, so 
 far as the rate-making is concerned. It is a vacillating quantity; it does not 
 represent in any sense the investment of the company in the construction 
 of the road. To illustrate : In the suit that was pending the estimated cos£ 
 of the reproduction of the Northern Pacific Railroad was involved. I am 
 informed the same engineer reported in 1907 and in 1909 as to the cost of 
 the reproduction new, and the value fixed in 1909 was one hundred and 
 eighty-five million dollars more than the same engineer fixed the value 
 of reproduction new in 1907.' 
 
 " Mr. La Follette [in part] : ' Let me say to the Senator on this question, 
 that the Supreme Court of the United States has listed that as one of the 
 values to be considered, and it has not yet by any express declaration elim- 
 inated it as a value to be ignored. So it seemed to the committee that we 
 ought to give it its place here. I will, however, say to the Senator that 7 am 
 confident that the views of all the advanced commissions of the country that 
 are doing this valuation work are that there should be very inconsiderable 
 weight given to reproduction new.' (Congressional Record, 3801.)" Quoted 
 from the decisions of Commissioner Shaw of Illinois in the Springfield and 
 Lincoln cases. See also Indianapolis Water Co. (Ind.) P.U.R. 1919-A- 
 448, etc.
 
 116 FAIR VALUE 
 
 sonable prudence in investment and honesty and efficiency 
 in operation, is all that can be allowed. 
 
 The Public-Service Commission of New Hampshire l 
 early recognized that property dedicated to the public use 
 should neither increase nor decrease on account of a change 
 in its reproduction cost; but that the utility should be en- 
 abled to earn a fair return upon the amount it had honestly 
 invested, so long as such return could be secured from 
 reasonable rates. The Wisconsin Railroad Commission 
 accepted the investment theory in Appleton v. Appleton 
 Water Works Company, 2 holding that the actual total in- 
 vestment in the enterprise should be made the basis of 
 valuation for rate-making whenever possible, though a 
 proper reconstruction appraisal might be of value as a 
 check upon or aid to original cost. The St. Louis Public 
 Service Commission in 1913 took a similar stand, holding 
 that the original-cost method is the preferable one where 
 there is no circumstance clearly indicating that the use of 
 the method would bring about an unjust result. 3 
 
 In the Middlesex and Boston Rate Case 4 the Massachu- 
 setts Public Service Commission, in accepting the original- 
 cost theory, said: 
 
 It is entirely clear that in the long rim the rate-paying public as 
 well as the investing public will be best served if regulation takes 
 as its fundamentally guiding principle an attempt to protect in- 
 vestments honestly and prudently made and wisely managed. Any 
 other theory involves essential injustice, tends to make the devel- 
 opment of our public utility companies a speculation and not an 
 investment, operates as a premium upon various kinds of fraud; 
 invites into the public service undesirable manipulators instead 
 of sound, level-headed business managers; makes every rate case 
 an almost interminable and labyrinthine inquiry into values with 
 endless conflicts between so-called experts. 
 
 In Edwards v. Glen Telephone Company 5 the New York 
 Second District Commission reached the conclusion that 
 
 1 Report of Nov. 30, 1912, p. 302. 2 5 W.R.C.R. 215. 
 
 3 Report on South Western T. & T. Co., Oct. 14, 1913. 
 
 4 October 28, 1914. B No. 4184, P.U.R. 1916-B-940.
 
 VALUATION METHODS 117 
 
 if the books of the utility had been carefully kept the actual 
 figures formed a rate base more equitable to both the public 
 and the utility than any figures based upon theory; and 
 that the company should not be given the benefit of a 
 highly inflated value upon its property merely because such 
 a value could be worked out from an imaginary reproduc- 
 tion cost regardless of what money had been actually in- 
 vested in the property. 
 
 In re Cripple Creek Water Company l the Colorado 
 Public Utilities Commission decided that while actual and 
 reproduction cost may well be taken as checks upon each 
 other, where original cost may be obtained accurately and 
 the investment was made honestly, wisely, and prudently, 
 the important test is the original cost to date, and esti- 
 mates of reproduction cost should receive slight considera- 
 tion. 
 
 In re Dunham, 2 the Missouri Public Service Commis- 
 sion took a similar stand, holding that original cost to date, 
 determined by a competent audit including the amount 
 expended in permanent improvements, furnishes the most 
 satisfactory evidence as to value because it is based on facts 
 capable of more or less exact determination under proper 
 accounting methods; and that, when expenditures prove to 
 have been reasonably required, with good business judg- 
 ment, and the appreciation or depreciation in value is in 
 evidence, the consideration of original cost to date is of pe- 
 culiar aid. 3 
 
 The recent cases devote little space to discussion of 
 either original or reproduction cost, but the clear tendency 
 is to modify the reproduction theory to make the results at- 
 
 1 P.U.R. 1916-C-788. See also In re Portland Ry. Light & P. Co. (Or.) 
 P.U.R. 1916-D-976. 
 
 2 P.U.R. 1916-E-544. 
 
 3 A majority of the State regulatory commissions have accepted the 
 actual-investment theory. See Bluefield v. Bluefield Waterworks & Imp. 
 Co. (W.Va.) P.U.R. 1917-E-22; Monroe Ind. Tel. Co. (Neb.) P.U.R. 
 1917-E-471; Lincoln v. Lincoln W. & L. Co. (111.) P.U.R. 1917-B-l; etc.
 
 118 FAIR VALUE 
 
 tained by it conform more closely to original cost. Greater 
 stress is placed upon original cost in an attempt to learn 
 what the actual, justifiable capital expenditure of the util- 
 ity has been. 
 
 The non-committal language and the reference to Smyth 
 v. Ames in Pine Lawn v. West St. Louis Water and Light 
 Company * are typical of the more recent decisions. The 
 actual well-camouflaged theory upon which they proceed 
 must be determined, if it can be found at all, by a careful 
 reading of the full decision, often of the full record, not 
 from any segregated portion of the decision. The Commis- 
 sion said: 
 
 We proceed to a consideration of all the matters presented in 
 evidence bearing upon value, particularly the "original cost of 
 construction, and the amount expended in permanent improve- 
 ments " which together are now generally known as the "original 
 cost to date," also "the present as compared with the original cost 
 of construction," which latter is presented in evidence as engi- 
 neers' estimates of the cost of reproducing the property new and 
 in its present condition, following the rule in the well-known case 
 of Smyth v. Ames. 2 
 
 Only one recent case, Re Indianapolis Water Company, 3 
 seriously disputes the investment theory, and while the 
 language used repudiates the doctrine, except as one of 
 many elements of value, the decision really raises but one 
 point inconsistent with that theory. The charge against 
 original cost is that it fails to consider appreciation. The 
 language relied upon by the Indiana Commission appearing 
 to make the most serious attack on the original-cost theory 
 is that used by the Federal Supreme Court in San Diego 
 Land and Town Company v. Jasper, where the Court says : 4 
 
 1 P.U.R. 1917-B-679, Missouri Public Service Commission. 
 
 2 See also Re Kansas City Elec. Light Co. (Mo.) P.U.R. 1917-C-718; 
 Portage v. Portage Water Co. (Pa.) P.U.R. 1917-D-17; Re Bronx G. &E. 
 Co. (N.Y. 1st Dist.) P.U.R. 1917-D-777 dictum; Greensburg o. West- 
 moreland Water Co. (Pa.) P.U.R. 1917-D-478. 
 
 3 P.U.R. 1917-E-556. 
 
 4 189 U.S. 442, 23 Sup. Ct. 571, 47 L. ed. 892.
 
 VALUATION METHODS 119 
 
 It is no longer open to dispute that under the Constitution 
 "what the company is entitled to demand, in order that it may 
 have just compensation, is a fair return upon the reasonable value 
 of the property at the time it is being used for the public." San 
 
 Diego Land & Town Co. v. National City, 174 U.S. 739 Thai 
 
 is decided and is decided as against the contention that you are to take 
 the actual cost of the plant, annual depreciation, etc., and to allow 
 a fair profit on that footing over and above expenses. 
 
 Thus far the statement, considered as an independent ab- 
 stract legal statement, would be fatal to the original-cost 
 theory; but the Court continues: 
 
 . . . The only evidence in favor of a higher value in the pres- 
 ent case is the original cost of the work, seemingly inflated by 
 improper charges to that account and by injudicious expenditures. 
 
 Thus it appears that the Court is not considering original 
 cost in the sense in which it has been since universally ac- 
 cepted, nor in the form in which the Indiana Commission de- 
 fined it, but has in mind the narrower, early construction 
 of the phrase synonymous with book value, which excludes 
 betterments and includes injudicious expenditures. The ob- 
 jection the Court raises is the direct opposite of the appre- 
 ciation theory of the Commission. Under the more liberal 
 construction the elements of value suggested by the utility 
 would have been excluded from the original-cost valuation 
 and the question passed upon by the Court could not have 
 arisen. 
 
 IX. The Supreme Court and Reproduction Cost 
 
 Both the original-cost and reproduction-cost theories of 
 valuation were first given definite form by the decision in 
 Smyth v. Ames. The next valuation case carried to the Su- 
 preme Court was San Diego Land and Town Company v. 
 National City, 1 decided the following year. In this case, 
 after carefully reviewing Smyth v. Ames, the Court states 
 the basis of calculation suggested by the applicant. That 
 
 1 174 U.S. 739, 19 Sup. Ct. 804, 43 L. ed. 1154.
 
 120 FAIR VALUE 
 
 basis makes no reference to present cost of construction or 
 to reproduction cost. The Court then proceeds to condemn 
 appellant's basis of calculation, not because it makes no 
 reference to reproduction cost, but because by not consider- 
 ing present value it works an injustice not to the utility but 
 to the consumer, for the original cost may well exceed the 
 present value. There is opportunity for reproduction cost 
 to be set up as a check upon investment, but the criticism 
 of the Court contains no reference to present cost of con- 
 struction or to reproduction cost. It seems evident that the 
 Court did not consider reproduction cost an essential ele- 
 ment of value It is probable, in view of the fact that the 
 Court had its recent decision in the Ames Case under con- 
 sideration, that Justice Brewer construed the language Jus- 
 tice Harlan had used as directing a comparison of present 
 value with original cost of production, rather than a com- 
 parison between reproduction and original cost, or else 
 considered reproduction cost as but a possible not a nec- 
 essary check upon the original-cost theory. The failure of 
 Justice Harlan to dissent from the decision may reasonably 
 be construed as indicating that no great injustice had been 
 done to his opinion. 
 
 The next Federal Supreme Court case in which the re- 
 production theory could arise as an issue was San Diego 
 Land and Town Company v. Jasper, 1 decided in 1902. In 
 this case the Court rejects original cost in its narrow sense 
 as the sole basis of value because it does not protect the pub- 
 lic from "inflated and improper charges" and "injudicious 
 expenditures." The standard of value fixed by the earlier 
 San Diego Case was accepted. Neither the language of 
 Smyth v. Ames nor the case itself was referred to. Neither 
 the present cost of construction nor reproduction cost was 
 suggested as a supplement to, or check upon, original 
 cost. The aim was the protection of the public, not the 
 utility. 
 
 1 189 U.S. 439, 23 Sup. Ct. 571, L. ed. 892.
 
 VALUATION METHODS 121 
 
 The next case involving this theory before the Federal 
 Supreme Court was Stanislaus County v. San Joaquin and 
 King's River Canal and Irrigation Company, 1 decided in 
 1904. The decision was based wholly upon the two San 
 Diego Cases cited above. Smyth v. Ames was referred to 
 only indirectly as having been followed in those cases. 
 Neither present construction nor reproduction cost was 
 mentioned. 
 
 Reproduction cost came before the Supreme Court as a 
 direct issue for the first time in 1909 in Knoxville v. Knox- 
 ville Water Company. 2 In discussing its use by the master 
 of the lower court, Justice Moody says: 
 
 The cost of reproduction is one way of ascertaining the present 
 value of a plant like that of a water company, but that tost would 
 lead to obviously incorrect results if the cost of reproduction is 
 not diminished by the depreciation which has come from age and 
 use. . . . The cost of reproduction is not always a fair measure of the 
 •present value of a plant which has been in use for many years. The 
 items composing the plant depreciate in value from year to year 
 in a varying degree. 
 
 After a lapse of eleven years the Court again discusses the 
 reproduction cost hinted at in the dictum of Smyth v. Ames. 
 It does not consider reproduction cost a necessary element 
 of value. The decision refers to no requirement in the Ames 
 Case. It merely says that such an element of value is admis- 
 sible if properly used, not as establishing a final valuation, 
 but as evidence of present value. The prodigal is welcomed 
 back, not with thanksgiving, but dubiously with criticism. 
 It is recognized, not as an end, but as a means toward an 
 end, and that end is the "fair present value" of the prop- 
 erty. It is evident, therefore, that the results obtained by 
 the reproduction method were not the fair present value, 
 but only one element in the indication of that value. 
 The Court stands just where it did in 1898; the reproduc- 
 
 1 192 U.S. 201, 62 Sup. Ct. 241, 48 L. ed. 406. 
 
 2 212 U.S. 1, 29 Sup. Ct. 149.
 
 122 FAIR VALUE 
 
 tion cost is a check upon actual investment to protect the 
 public from "inflated and improper charges" and "injudi- 
 cious expenditures." 
 
 In Willcox v. Consolidated Gas Company 1 the Court had 
 occasion to state the test of rate reasonableness again, the 
 same year. It fixed " the fair present value" as the criterion. 
 No specific mention was made of present cost or reproduc- 
 tion cost. The decision, however, seems based upon the 
 latter theory. In considering present value, the Court said: 
 
 If the property which legally enters into the consideration of 
 the question of rates has increased in value since it was acquired, 
 the company is entitled to the benefit of such increase. That is, at 
 any rate, the general rule. We do not say there may not possibly 
 be an exception to it where the property may have increased so 
 enormously as to render a rate permitting a reasonable return 
 upon such increased value unjust to the public. 
 
 This case marks the climax of reproduction-cost valu- 
 ation. The fruits of unrestrained flights of imagination 
 through the capital accounts here reach a point which ren- 
 ders a reaction inevitable. The Court has lost sight of both 
 the aim and the basis of regulation. It is thinking only of 
 the safeguards of private property and disregarding wholly 
 the purpose of property and the social interest therein. 
 The result of the narrowed vision was that the Court went 
 astray on the one phase of the question it did have in mind. 
 It in effect gives private property in the regulated business 
 greater protection than it would have enjoyed in the absence 
 of regulation by guaranteeing a return on a non-productive 
 element of value. This is, to say the least, straining the Con- 
 stitution to the limit. 
 
 The holding even here, however, does not attempt to 
 saddle the burden of increased prices of material and in- 
 creased wages, the cost of paving never cut, and other 
 imaginary values of the strained reproduction theory upon 
 the public for the benefit of a utility which never paid the 
 1 212 U.S. 19, 29 Sup. Ct. 192, 53 L. ed. 382.
 
 VALUATION METHODS 123 
 
 increased prices. The Supreme Court has never sanctioned 
 the conjectural reproduction-cost theory for any use in 
 valuation. The intent of the decision was merely to allow 
 the utility in common with all others the benefit of increased 
 values. It is but a restatement and explanation of the doc- 
 trine of the San Diego Cases upon which it is predicted. 
 
 In Lincoln Gas and Electric Light Company v. Lincoln l 
 the reproduction cost was used by the master "as one 
 means of finding the present value." The Court did not 
 refer to the propriety or impropriety of the means, but re- 
 stated the rule of the San Diego Case and remanded the 
 case for the lower court to determine value more accurately 
 than had been done. 
 
 In Simpson v. Shepard, 2 commonly known as the Second 
 Minnesota Rate Case, the Court reverts to the rule of 
 Smyth v. Ames, restating it without comment. That rule 
 stated substantially the system followed by the master in 
 appraising the property, though his final valuation was 
 based on the reproduction cost. In commenting upon this 
 finding the Court said: 
 
 It is manifest that an attempt to estimate what would be the 
 actual cost of acquiring the right of way if the railroad were not 
 there is to indulge in mere speculation. The railroad has long been 
 established; to it have been linked the activities of agriculture, 
 industry, and trade. Communities have long been dependent 
 upon its service, and their growth and development have been 
 conditioned upon the facilities it has provided. The uses of prop- 
 erty in the communities which it serves are to a large degree de- 
 termined by it. The values of property along its line largely de- 
 pend upon its existence. It is an integral part of the communal 
 life. The assumption of its non-existence, and at the same time 
 that the value that rests upon it remains unchanged, is impossible 
 and cannot be entertained. The conditions of ownership of the 
 property and the amounts which would have to be paid in acquir- 
 ing the right of way, supposing the railroad to be removed, are 
 wholly beyond reach of any -process of rational determination. 
 The cost-qf-reproduction method is of service in ascertaining the 
 
 1 223 U.S. 349. 2 230 U.S. 352, 33 Sup. Ct. 729.
 
 124 FAIR VALUE 
 
 present value of the plant, when it is reasonably applied and when 
 the cost of reproducing the property may be ascertained with a proper 
 degree of certainty. But it does not justify the acceptance of results 
 which depend upon mere conjecture. It is fundamental that the 
 judicial power to declare legislative action invalid upon constitu- 
 tional grounds is to be exercised only in clear cases. The consti- 
 tutional invalidity must be manifest, and if it rests upon disputed 
 questions of fact, the invalidating facts must be proved. And this 
 is as true of asserted value as of any other fact. 
 
 The Court clearly sounds the death-knell of the claim of 
 reproduction-cost advocates that that theory is to be 
 adopted as the sole measure of present value. It fixes the 
 true place of the theory with equal clearness. Reproduction 
 cost when rightly used is of worth in determining fair 
 present value. It is too speculative to be trusted alone, 
 but as a check upon other estimates it is admissible, con- 
 ditioned always upon its being fairly used. 
 
 The Second Minnesota Rate Case is the most recent com- 
 ment of the Supreme Court upon reproduction cost. It 
 leaves little room for further discussion by future cases. 
 
 X. Summary 
 
 Fair value deals primarily with valuation for rate-mak- 
 ing purposes. The fair value discussed is the present rea- 
 sonable investment represented by the tangible and intan- 
 gible property which the utility owns. It is based upon 
 original-cost and reproduction-cost appraisals showing the 
 total investment in the property. The final valuation is 
 worked out from the inventory figures and the corporate 
 history which accompanies them as a sort of exhibit or 
 supplement. The aim is to determine the actual, unim- 
 paired, reasonable investment in property used and useful 
 in rendering the public service. For this purpose the origi- 
 nal-cost appraisal serves best, when accurately drawn. The 
 reproduction-cost appraisal, when it approximates facts 
 and avoids the flights of fancy which have so often marred 
 it in the past, is serviceable as a check upon and supple-
 
 VALUATION METHODS 125 
 
 ment to the original-cost estimate. The final valuation is a 
 heterogeneous estimate based in part upon original cost, 
 in part upon reproduction cost, excluding all values not 
 used or useful for the public service, deducting depreciation 
 from the inventory figures to arrive at present value or un- 
 impaired investment, and taking into consideration all the 
 equities of the particular case. It follows no definite for- 
 mula, it acknowledges no binding precedent. It is based 
 on natural justice and equity, bounded by the constitu- 
 tional safeguards of property, the necessity of attracting 
 capital, and the dominating limitation that rates must not 
 be fixed above the value of the service.
 
 part n 
 
 THE APPLICATION OF THE THEORY OF FAIR VALUE
 
 CHAPTER VI 
 THE VALUATION OF TANGIBLE PROPERTY 
 
 I. Tangible and Intangible Values 
 
 The property representing the reasonable unimpaired 
 investment is of two kinds, tangible and intangible. The 
 tangible property of the utility includes its lands, buildings, 
 equipment, and property interests, including water rights. 
 The intangible property is almost innumerable, depending 
 in the reproduction inventory upon the versatility of the 
 appraiser's mind. It includes organization costs, engineer- 
 ing, superintendence, legal expenses, contingency allow- 
 ances, etc. 
 
 We are here concerned with tangible property. Its valua- 
 tion is less speculative. Two problems are encountered: (1) 
 what property items are to be included in the final valua- 
 tion; (2) to what extent has the investment in those items 
 been depreciated by ordinary wear and tear and by obso- 
 lescence. We deal now with the first of these questions. 
 
 II. Property not Used or Useful 
 
 Not all property value of the utility can be allowed for 
 rate-making purposes. Often the company seeks to carry in 
 its capital account large values representing discarded prop- 
 erty. Real estate no longer required for utility purposes 
 held pending an advantageous sale, machinery superseded 
 by more modern equipment before being junked, power 
 plants held for emergency use in connection with trans- 
 mission-line service, and similar items, some with a sem- 
 blance of present usefulness, none with a present use, are 
 retained in the capital account. A valuable tract of land 
 suitable for an office or power site may be used for storage 
 when a much cheaper lot would serve the purpose equally
 
 130 FAIR VALUE 
 
 well. A structure may be built with capacity far in excess of 
 the needs of the present or immediate future. Lands may be 
 purchased at an opportune time to be held fot distant use 
 as a terminal site, etc. The valuation rule in such cases 
 when a rate-making base is sought is that applied in all 
 cost estimates for price-fixing. Only the property used and 
 useful in rendering the service under consideration can be 
 valued. 1 The charge for unused property must be made to 
 profit and loss. 
 
 The valuation rule generally applied in such cases is 
 stated in the La Crosse Gas and Electric Company Case, 2 
 thus: 
 
 When such non-operating property is held by a utility, the 
 only warrant for its retention is expected savings and additional 
 net income. This being the case, an addition to the physical value 
 of the plant for non-operating property can be justified for rate- 
 making purposes only when the income expected therefrom is 
 added to the actual income or is deducted from the operating 
 expenses. 
 
 And in the case of the Darlington Electric Light and Water 
 Power Company : 3 
 
 Where equipment not actually part of the producing plant has 
 been retained and serves as an emergency or reserve unit, it is 
 properly included as property used and useful in serving the pub- 
 lic. Equipment, however, which has been cast aside for larger 
 units, more adapted to the present use of the plant, or which has 
 been abandoned as impracticable, cannot be included. 
 
 1 The State Commissions are unanimous in holding that abandoned 
 equipment and property not used or useful in the utility business must be 
 excluded from the valuation unless it is held to meet the reasonable need 
 of the immediate future. The leeway allowed under this exception varies 
 somewhat, being greater in those States still in the development stage and 
 in one or two jurisdictions undeniably pro-utility in their sentiment. In 
 California, Illinois, Massachusetts, New York, and Wisconsin provision 
 for future needs is limited as far as possible without handicapping effi- 
 cient management. Property used only for revenue, such as a house rented 
 out, stock in trade, stock in other companies, etc., has also been excluded 
 without exception. It seems useless, in the absence of dissent, to cite the 
 long line of decisions from the many jurisdictions. 
 
 2 8 W.R.C.R. 138, 164. 3 5 W.R.C.R. 397.
 
 VALUATION OF TANGIBLE PROPERTY 131 
 
 In considering construction for future needs the Federal 
 Supreme Court excluded excessive investment in San Diego 
 Land and Town Company v. Jasper, 1 on the theory that if 
 a plant is built for a larger area than it finds itself able to 
 supply, or if it has not secured the customers contemplated, 
 neither justice nor the Constitution requires that part of 
 the contemplated number should pay the full return. 
 
 Where the investment was made at the order of the city 
 and rendered useless by its action without fault of the util- 
 ity, the Wisconsin Commission "as a matter of simple jus- 
 tice" refused to exclude entirely the property from the val- 
 uation. 2 
 
 There seems to be little room to question the equity of 
 refusing to force the public to pay rates upon property 
 which is neither used nor useful in rendering the service it 
 receives. A valuation including such property would force 
 rates above limits fixed by the value of the service, a limit 
 imposed upon the utilities by the Federal Supreme Court. 
 It would violate all laws of cost determination and disre- 
 gard all principles of economics. The exclusion of such prop- 
 erty from the valuation can raise no question of property 
 rights under the Fourteenth Amendment, for the property 
 not being used the use is not taken and compensation can- 
 not be required. 
 
 Where the property is held for emergency use, however, 
 the case is quite different. There is an actual stand-by, read- 
 iness-to-serve use rendered the consumer who pays the rate. 
 The service if reasonable in extent is a legitimate part of the 
 regular utility business. Such property must be included in 
 the valuation to the full extent of its worth for the use to 
 which it is put. The question is complicated. The actual in- 
 vestment ceases to be the determining element. 3 What part 
 
 1 189 U.S. 439, 446, 23 Sup. Ct. 571, 47 L. ed. 892. 
 
 2 Re Manitowoc Water Works Co., 7 W.R.C.R. 71, 80. 
 
 3 The problem here presented illustrates the necessity of keeping in 
 mind constantly the fact that cost of service is the element primarily 
 sought. Value of the property is involved only in so far as it is a feature
 
 132 FAIR VALUE 
 
 of this equipment is really used as an emergency plant? 
 What is the investment in property at present used in ren- 
 dering utility service? What part of the original investment 
 has been withdrawn or replaced? The problem seems to be- 
 come, What would it be reasonable for the utility under 
 existing conditions to invest in such service? This line of 
 reasoning, however, involves the fallacies of the substitute- 
 plant idea, discarded as a basis for determining cost of serv- 
 ice because it deals with value, not cost. The problem is 
 merely one of apportionment to determine the part of the 
 investment actually used. The utility is entitled to more 
 than junk value because actual service is rendered; it is not 
 entitled to actual investment because the service for which 
 the investment was made is no longer rendered. Invest- 
 ment, however, must remain the measure of the rate-mak- 
 ing value of such equipment so long as the management is 
 justified in retaining it in the emergency service at all. 
 
 Excessive investment to meet anticipated future de- 
 mands presents still another problem. Adequate provision 
 for future requirements which must arise within the imme- 
 diate future are a necessary capital expenditure. Any sound 
 management must make comprehensive preparation for 
 future needs. Within reasonable limits such expenditures 
 provide a present service. But investment made for future 
 needs where the contingency is remote is but a specula- 
 tion indulged in by the utility. The cost of the venture can- 
 not be taxed against the consumer before the property is 
 actually used. Excessive and unreasonable investment in 
 property which may sometime be useful in rendering the 
 service, so far as present consumers, present rates, and pres- 
 ent value are concerned, stands in no different position 
 from any other property not used or useful. In the border- 
 
 of cost of service. Where the property is not used at all or is used in part 
 only in rendering the service, the total value of the property cannot be 
 included in the rate-base valuation. It would not be a proper charge to 
 cost. ~~*
 
 VALUATION OF TANGIBLE PROPERTY 133 
 
 land between reasonable and unreasonable investment for 
 future needs, between sound business foresight and specu- 
 lation, the investor must assume the entire responsibility 
 for his judgment. 
 
 III. Property Acquired without Cost 
 
 The fact that the rate-making valuation deals primarily 
 with investment and cost, rather than with value, raises 
 the question whether property acquired by way of gift, 
 or otherwise without cost to the investor, may properly be 
 included in the final valuation for rate-making purposes. 
 The early cases, for the most part, misled by the term 
 "present value," took the view that because the title to 
 the property vested in the utility, its value should be in- 
 cluded for rate-making purposes. 1 The reasoning seems 
 fallacious. 
 
 Such property represents no sacrifice, investment, or 
 element in the cost of service until replacement is necessary; 
 because the gift creates a clear implied trust and the utility 
 holds but the naked title, the beneficiary interest being in 
 the consumers. If the gift were not so restricted, if the util- 
 ity were not engaged in rendering a governmental service, 
 the donee would be entitled to the benefits from the use by 
 way of a return; and to a depreciation allowance to keep his 
 investment intact. 
 
 The better view of the question, and that adopted by 
 courts and commissions in the more recent cases, is that 
 property which does not represent real investment or sac- 
 rifice on the part of the stockholders cannot be included in 
 
 1 Findings as to Value of Railroads, R.R. Comm. of Wash. 1907-08, pp. 
 127, 449; Buell v. Chicago, M. & St. P. Ry., 1 W.R.C.R. 324, 356; Steener- 
 son v. Gt. Northern Ry., 69 Minn. 353, 72 N. W. 713; Tighe v. Clinton 
 Tel. Co., 3 W.R.C.R. 117, 126; Shepard v. N. Pacific Ry., 184 Fed. 765; 
 N.Y.N.H. & Hartford R.R., Rept. Mass. Joint Comm. 1911, pp. 51-54; 
 Central of Georgia Ry. v. R.R. Comm. of Ga., U.S. Dist. Ct. Middle 
 Dist. Ala. No. 261, Equity; Central P.R.R. (Cal.) P.U.R. 1916-B-845; 
 Bd. of Trade v. Mountain Home Tel. Co. (N.Y. 2d Dist.) P.U.R. 1916- 
 C-688; etc.
 
 134 FAIR VALUE 
 
 the rate valuation. 1 This view certainly conforms more 
 closely to the purpose of valuation than the earlier rulings 
 did. Thus service pipes and service wires constructed by the 
 consumer at his expense cannot be included in a valuation 
 of the company's property for rate-making, and right of 
 way or other land donated for utility use must be excluded. 2 
 
 IV. Property Acquired from Surplus 
 
 The problem of valuation of property created from sur- 
 plus earnings is closely allied to that of property acquired 
 without actual expenditure by the stockholders. Where the 
 surplus put into additions and betterments represents earn- 
 ings above a fair return on the investment, it would seem 
 that the property thus acquired could differ little from prop- 
 erty vesting in the utility by way of gift or private construc- 
 
 1 San Diego Water Co. r. San Diego, 118 Cal. 556, 50 Pac. 633; Ash- 
 land v. Ashland Water Co., 4 W.R.C.R. 273; Ripon v. Ripon Light & 
 Water Co., 5 W.R.C.R. 1, 10; Washburn c. Washburn Water Works 
 Co., 6 W.R.C.R. 74, 92; Beloit v. Beloit Water, Gas & Electric Co., 7 
 W.R.C.R. 187, 215; Marin Municipal Water Dist. (Cal.) P.U.R. 1915-C- 
 433; Pine Lawn v. West St. Louis Water & Light Co. (Mo.) P.U.R. 1917- 
 B-679; and cases cited in Note 3. 
 
 2 "The real question is, how many services the company paid for . . . 
 where a service is laid in the land of the consumer and extended through 
 the street to the main in front of his house and paid for by him, it becomes 
 his property and not the property of the company. If the company is to be 
 allowed in its capital account for such a main, then the consumer must con- 
 tinue in perpetuity to pay a return of at least 6 per cent to the company 
 upon property which he, the consumer, has paid for. It is clear that this is 
 neither reasonable nor just, and cannot be permitted." Buffalo Gas Co. r. 
 Buffalo, 3 P.S.C. (2d Dist. N.Y.) 553; The holding has been the same 
 where pole lines and wires constructed by the consumer have become an 
 actual part of the utility's property. See also Beloit v. Beloit Water, G. & 
 E. Co., 7 W.R.C.R. 187, 215; San Diego Water Co. v. San Diego, 118 Cal. 
 556, 50 Pac. 633; San Diego Consol. G. & E. Co. (Cal.) P.U.R. 1917-A-930; 
 Sandpoint v. Sandpoint Water & L. Co. (Idaho) P.U.R. 1915-F-445; Apple 
 v. Brazil (Ind.) P.U.R. 1915-C-561; Commercial Club v. Terre Haute 
 Waterworks (Ind.) P.U.R. 1916-B-180; Commercial Club v. Citizens G. 
 & E. Co. (Ind.)P.U.R. 1916-E-l ; Thayer v. Beaver Valley Water Co. (Pa.) 
 P.U.R. 1916-E-962; San Gabriel Valley Water Co. (Cal.) P.U.R. 1916- 
 B-895; Re Purchase Oshkosh Water Works Plant, 12 W.R.C.R. 602; 
 Superior Commercial Club v. Duluth St. Ry. Co.,12 W.R.C.R. 1; etc.
 
 VALUATION OF TANGIBLE PROPERTY 135 
 
 tion. The two cases, however, are essentially different. 
 Property acquired from surplus always represents sacrifice 
 and actual investment by the stockholders. Donated prop- 
 erty does not. 
 
 It is undeniable that profits in excess of a fair return upon 
 the investment should be distributed by way of low rates or 
 impressed with a trust character for the benefit of the pub- 
 lic. But where the public has found it expedient to adopt 
 a laissez-faire policy to encourage utility development, it 
 cannot be said that rates unduly high were illegally col- 
 lected in the absence of regulation. The title to the surplus 
 vested without limitation or condition in the shareholder as 
 a reward for investing in a venture which the public itself 
 deemed so speculative that regulation should be waived. 
 This being true, the waiver of the right to declare a divi- 
 dend and the creation of additions and betterments from 
 the dividend-available surplus represents just as great a 
 sacrifice, just as real an investment as it would had the 
 f ormality of declaring a dividend and reinvesting the funds 
 been indulged in. 
 
 In the case of donation or land grant, the aid has been 
 given for a specific purpose and it requires no great strain 
 upon the imagination to conceive of it as the creation of an 
 implied trust to use the property donated for the public 
 benefit. The payment of excessive rates, however, differs 
 materially. It carried with it no requirement that the funds 
 be left in the business or used for the public benefit. The im- 
 plied trust doctrine could not be applied. Its strained appli- 
 cation would only penalize those who came nearest to bene- 
 fiting the public. 
 
 Where the invested surplus arises from a waiver of the 
 right to declare dividends from the funds included in the 
 fair return upon the investment, there can be little ques- 
 tion but that the property acquired from it should be val- 
 ued for rate-making. 
 
 There have been few court or commission rulings upon
 
 136 FAIR VALUE 
 
 the question of invested surplus and such decisions as have 
 been rendered have not been uniform. 1 The problem was 
 discussed at length by the Massachusetts Commission in 
 Re Haverhill Gas Light Company. 2 The evidence showed 
 that the utility had gradually accumulated a large surplus 
 which it had invested in the property. Its rates had been as 
 low or lower than those of other companies of the same class 
 in the State, and the quality of the service had been the 
 best. The accumulation appeared to have been due to ex- 
 ceptional management and to a rapid gain in wealth and 
 population in the community supplied. The Commission 
 held that since the property in which the surplus had been 
 invested must otherwise have been secured by new capital 
 contributed by the shareholders, it should be used to the 
 substantial benefit of consumers and shareholders alike. It 
 should benefit the former by relieving them of part of the 
 burden which the investment of additional capital imposes, 
 by affording ready facility for minor extensions, etc. It 
 should benefit the stockholders by strengthening the corpo- 
 ration, enhancing the security of the original investments, 
 and in bringing a higher return than otherwise. Such a sur- 
 plus, the Commission admits, is by every principle of law 
 the property of the corporation, which has an undoubted 
 legal right to distribute it as a dividend as it is acquired, or 
 
 1 It has been frequently held that surplus investment must be valued 
 for rate-making when charges have not been exorbitant or when the sur- 
 plus has arisen by reason of failure to declare dividends. See Bridgeport 
 Natural Gas & Oil Co. (W. Va.) P.U.R. 1916-C-253; Re Valparaiso Tel. 
 Co. (Neb.) P.U.R. 1915-E-578; Re Salem Tel. Co. (S. Dak.) P.U.R. 
 1919-B-734. It has been held unreservedly that all investments from sur- 
 plus are properly valued; see Brymer v. Butler Water Co., 179 Pa. 231, 36 
 Atl. 249; Spokane v. N. Pac. Ry. Co., 15 I.C.C. 376, 416; Fall River Gas 
 Works v. Bd. of Gas & Elec. L. Comm., 214 Mass. 529, 102 N.E. 475; 
 Charlesworth v. Omro Elec. L. Co. (Wis.) P.U.R. 1915-B-l; Re Los An- 
 geles (Cal.) P.U.R. 1916-F-593. Another line of cases holds as unquali- 
 fiedly that additions and betterments paid for out of earnings form no 
 part of the investment for rate-making; see Bay State Rate Case (Mass.) 
 P.U.R. 1916-F-221; Landona. Lawrence (Kan.) P.U.R. 1916-B-331. 
 
 2 Mass. Bd. of Gas & Elec. L. Comm., 9th Ann. Rept. p. 90.
 
 VALUATION OF TANGIBLE PROPERTY 137 
 
 pro rata to the shareholders in case of liquidation. Notwith- 
 standing this, the Commission contends, the circumstances 
 attending the accumulation of the surplus impose upon the 
 company, so long as it continues to exercise the functions 
 of a public monopoly, the duty to employ it for the joint 
 advantage of the consumers and the corporation. 
 
 The Commission erred in its application of the theory of 
 public interest. All public-utility property is affected with 
 a public interest. But the encumbrance thus created is iden- 
 tical in all cases. The origin of the private title to the prop- 
 erty cannot affect that interest. It deals with the use, not 
 the title, of the property. A trust may be imposed upon the 
 property, or title granted upon restrictive conditions, but 
 the encumbrances thus created are imposed in addition to 
 the general public interest that arises from the use of the 
 property in the public service. The two types of encum- 
 brances are quite distinct. Unless a specific limitation can 
 be shown, similar to those implied from donation or acquisi- 
 tion of title by way of eminent domain, invested surplus 
 stands in no different position from other investment in 
 the public service. 
 
 It has been argued l that the public has paid for addi- 
 tions and betterments made from earnings. When it is ad- 
 mitted, as it must be, in view of existing law, that the excess 
 profits were the unrestricted legal property of the com- 
 pany, and ceased to be funds of the public, before the deci- 
 sion to divert them to either dividends or additions and 
 betterments was made, it is difficult to see how this theory 
 can be sustained. The public has no more paid for addition 
 made from legal surplus than for betterments made from 
 capital earned as fair return upon the reasonable invest- 
 ment declared as dividends and reinvested in the securities 
 of the utility. 
 
 Additions and betterments created from surplus earnings 
 
 1 New Hampshire Pub. Serv. Comm. Rept. on Investigation of Rail- 
 road Rates, Nov. 30. 1912.
 
 138 FAIR VALUE 
 
 are investments and, if used and useful in rendering the 
 public service, must be included in valuation for rate-mak- 
 ing purposes if the rate base is to stand the test of the due- 
 process clause of the Fourteenth Amendment. 
 
 This reasoning applies, however, only to additions and 
 betterments. When the expenditures were made for replace- 
 ments the equipment cannot be capitalized to include the 
 new expenditure. When the surplus was made up of funds 
 which should have constituted a depreciation reserve, but 
 were not so designated by law, the remedy for failure to set 
 aside the fund is by subtracting accrued depreciation from 
 the original investment rather than by disregarding the new 
 capital expenditures. The results are the same in either 
 case. 
 
 V. The Valuation of Land 
 
 The determination of land value is the most perplexing 
 problem in the valuation of tangible property, and one of 
 the most troublesome phases of public utility regulation. 
 Little assistance can be gleaned from the court decisions. 
 The Supreme Court has made few rulings upon land value, 
 outside decision in the Second Minnesota Rate Case; and 
 practically all of its decisions on this question have been 
 rendered in connection with reproduction-cost appraisals. 
 Since that theory not only never has received the sanction 
 of the Court as a sole basis for final value, but has been de- 
 finitely rejected for that purpose, it follows that the utter- 
 ances of the Court, so far as they carry weight as precedent, 
 must be restricted to the limited area of the reproduction- 
 cost appraisal. 
 
 The attempts at land valuation have been haphazard. 
 Under the plea of the magnitude of the task, multiple and 
 percentage methods of guesswork valuation have been em- 
 ployed, which can find the slight excuse they own, only in 
 the general chaotic state of valuation matters. From the 
 jumbled experiments three fairly well-organized methods
 
 VALUATION OF TANGIBLE PROPERTY 139 
 
 of land appraisal have been developed. They are the local- 
 expert method, the sales method, and the appraiser method. 
 They apply, of course, only in the reproduction-cost and 
 estimated original-cost inventories. 
 
 The local-expert method of valuing land is but the basing 
 of the appraisal on the opinion evidence of local real-estate 
 experts. Nothing could be more uncertain than such opinion 
 evidence as to real-estate values. The value of the testimony 
 depends entirely upon the care, labor, ability, training, and 
 honesty of the appraiser. 
 
 The sales method assumes to collect and compare sys- 
 tematically the data relating to the transfers of neighboring 
 property having conditions or characteristics similar to the 
 land whose value is to be determined. It seeks to determine 
 the true market value of the land. And it attempts to do 
 this by duplicating as nearly as possible the process em- 
 ployed by the local expert. The aim is to reach conclusions 
 as to value approximating those which would be reached 
 by such experts acting wholly without prejudice. 
 
 The two methods base value upon the same evidentiary 
 facts, but the sales method substitutes the opinion of the 
 Commission for that of the expert witness. The appraiser 
 method differs but slightly from the sales method. It at- 
 tempts to apply the judicial process of the assessor instead 
 of the non- judicial "mental process" of the local expert. 
 
 These methods have all been criticized because they are 
 based upon an estimate. Business investments are made, 
 loans effected, taxes levied, and general credit based on 
 exactly similar estimates of land value. Any form of land 
 valuation other than actual investment figures must be an 
 estimate of the value by some one or other. The aim is 
 merely to make that estimate as fair as possible to all the 
 parties concerned. 
 
 All three of these forms of valuation seem to be out of 
 accord with the general theory of rate valuation. They at- 
 tempt to determine market value while rate value is cost,
 
 140 FAIR VALUE 
 
 i.e., reasonable present investment. This fallacy is, of 
 course, cured to a large extent when the market value 
 sought is that at the time of the purchase by the utility, 
 since such market value must approximate the actual in- 
 vestment. The same reasoning holds that market value of 
 surrounding, similar land is the proper estimate of land 
 value for the reproduction-cost appraisal. 
 
 VI. The Original-Cost Appraisal 
 
 Original cost, where it can be obtained from the books of 
 the company or estimated with a fair degree of accuracy, 
 must be the controlling factor in the final valuation of lands 
 for rate-making. 1 It alone is based upon the actual invest- 
 ment which rate valuation seeks to ascertain. When prop- 
 erly determined, the original-cost appraisal need only be 
 questioned concerning the fitness of the property and its 
 actual use in the service, to determine the final land value 
 for rate-making. 
 
 Two serious questions concerning land value may arise 
 when the appraisal is based upon actual records. It may 
 have happened that the land, when acquired, was improved 
 with buildings unsuitable for utility use. The first question 
 is, Shall the land be valued for rate-making at the purchase 
 price, or at that price plus the cost of removal less the sal- 
 vage value of the buildings? It may have been necessary in 
 making improvements upon the property as acquired to 
 
 1 The importance attached to this figure by the State Commissions is 
 demonstrated by the Report of the Committee on Valuation of the Nat'l 
 Ass'n of Railway Commissioners, Nov. 1916, 28th Annual Report, p. 197: 
 "Original cost is believed by the members of this Committee to be the 
 strongly controlling factor in the ultimate determination as to the weight 
 to be accorded land values in a rate case. . . . There are practical difficul- 
 ties in many cases in determining the original cost of the present property. 
 . . . But as the disputed principles in land appraisals involve sums aggre- 
 gating fully half the outstanding nominal capitalization of the entire rail- 
 road system of the Nation, this Committee has urged that no obstacle not 
 insuperable be permitted to prevent the most detailed and accurate state- 
 ment of these important facts."
 
 VALUATION OF TANGIBLE PROPERTY 141 
 
 make outlays of a temporary nature or of such character 
 that they have ceased to be apparent. The second ques- 
 tion is, What portion of such expenditures shall be in- 
 cluded in the final valuation? 
 
 The removal of unsuitable buildings is a legitimate part 
 of the cost of acquiring the land, providing the site was a 
 reasonable one under the conditions. But any revenue de- 
 rived from the sale of the buildings must be credited to the 
 cost, and the land be valued for rate-making at the re- 
 sulting figure. It is only thus that the actual necessary sac- 
 rifice or investment can be determined. 
 
 All reasonable unimpaired investment must be included 
 in the valuation. Expenditures for a temporary structure 
 necessary to the erection of a permanent bridge form a part 
 of the cost of the bridge and depreciate with the loss of 
 utility of the permanent structure. The cost of ballast 
 merged with the soil keeps a lessening worth so long as 
 the ballast retains its identity and serves a real purpose 
 in rendering the public service. Fills, grading, and foun- 
 dations, reasonable in extent, constitute a proper element 
 of rate value so long as they are used or useful. 
 
 VII. Appreciation of Land Values 
 
 The principal objection to the original-cost valuation of 
 land, advanced by the utilities, is that it excludes appre- 
 ciated value. The issue thus raised is that which underlies 
 all valuation, i.e., is value or cost sought? It has been de- 
 cided in general in favor of cost. 
 
 It is difficult, on strict analysis, to see just how original- 
 cost valuation for rate-making works a hardship if regula- 
 tion is justifiable at all. Modern regulation first sets up a 
 monopolistic business, then imposes on it the restrictions 
 of competitive rate-making. It may prove profitable, there- 
 fore, to consider the action of competitive forces with re- 
 spect to appreciation. Competition is subject to the same 
 criticism as original-cost valuation. It lacks respect for the
 
 142 FAIR VALUE 
 
 alleged divine right to profits based on appreciated value. 
 One manufacturer cannot demand more for his product 
 than a near-by competitor simply because his factory site 
 has risen in value more rapidly, especially if the rise in 
 value is wholly dependent upon the use of the property in 
 other lines of business. If he wishes to take immediate ad- 
 vantage of the increased value, he must sell out and find a 
 less valuable site for his plant. If he continues to occupy 
 the more valuable site, competition will force him to accept 
 a return based upon his investment, not the value of his 
 land. If his business is a public service he has voluntarily 
 waived the right arbitrarily to dispose of the property to 
 secure the increased market values, presumably in consider- 
 ation of the decreased risks of the utility business. The 
 moment the "unearned" increment grows to any consider- 
 able magnitude, if regulation is justifiable at all, the prop- 
 erty becomes too valuable for utility purposes and the ex- 
 cess value will not be used or useful property within the 
 meaning of the law. Successful regulation can establish no 
 greater rate basis than competition allows. 
 
 One of the chief aims of regulation, it will be remembered, 
 is the elimination of speculation, by placing of the public 
 service upon a sound business basis and limiting the return. 
 To base the return upon appreciated value would reopen 
 the door to manipulation and speculation, produce fluctuat- 
 ing rates, and bring back the elements of every phase of 
 instability which regulation seeks to eliminate. 
 
 The champion of appreciated rate value must contend 
 that the increment is "new investment," the use of which 
 is taken by the public within the meaning of the due-pro- 
 cess clause. It is necessary, in order to substantiate this 
 claim, to show first that the "new investment" is used by 
 the public; that the use is taken. Appreciation is a value in 
 futuro resting only upon the disposal of the land, fluctuating 
 with conditions, and undeterminable in amount while con- 
 tingent; and the owner, in consideration of franchise privi-
 
 VALUATION OF TANGIBLE PROPERTY 143 
 
 leges, the use of a portion of the State's sovereignty, the 
 assurance of the benefits of the economies possible under 
 monopolistic organization, and the decreased risks under 
 government regulation, has covenanted to use the land for 
 a certain purpose and refrain from arbitrarily disposing of 
 it for his own benefit. Be it ever so valuable for another 
 purpose, therefore, the land has not increased in value for 
 the utility service. The consumer gets no better service. 
 No legal title to increased value rests in the owner. He can- 
 not demand appreciation as a right. It may or may not come. 
 It is a wholly incidental increase, speculative and liable to 
 disappear with the next turn of the wheel. The alleged new 
 investment stands in no different position from other prop- 
 erty neither used nor useful. To hold otherwise would be to 
 separate cost of service and value of service, and give the 
 term "cost" the rejected meaning of actual cost rather than 
 the accepted meaning of reasonable cost. The advocate of 
 appreciated value for rate-making closes his eyes to the 
 value-of-service limitation to which the Supreme Court 
 has more unswervingly adhered than to the cost-of -service 
 rule itself. 
 
 It may be of assistance here to revert to the considera- 
 tion of the nature of private property. It is a bundle of 
 rights existing for the benefit of the public and increasing 
 or decreasing numerically as the public directs by way of 
 the police power. In the case of appreciation the public 
 welfare requires that rates be limited to cost, that 
 appreciated land value be left to the owners to vest at their 
 current value when the land is disposed of, but that so long 
 as the land is employed in the public service those values 
 cannot be considered in rate-making, since they require 
 no additional sacrifice or outlay and they add nothing 
 to the service rendered. The limitation is characteristic of 
 all government regulation and no more retroactive than 
 any other limitation upon private property rights in 
 promotion of the common good. The contingent right to
 
 144 FAIR VALUE 
 
 the increased value, if it is not wiped out before the land is 
 sold, is not within the protection of the due-process clause 
 because it does not add to the service, and the service, not 
 the property, is the thing taken and to be paid for. Only 
 property values directly contributing to the service taken 
 can be brought within the limitations of the Fourteenth 
 Amendment. 
 
 Justice Van Fleet, in San Diego Water Company v. 
 San Diego, 1 in considering the general problem of increase 
 in values held that it would be unjust to permit consumers 
 to plead that a similar works could now be constructed at 
 a less cost, and equally unjust to require them to pay an 
 enhanced price on the ground that it would now cost more 
 to construct similar works. Such a contingency might hap- 
 pen, the Court agreed, but to increase rates for that reason 
 would allow the company to make a profit, not as a reward 
 for its expenditures and services, but by way of a speculation 
 in which the company or consumer wins or loses upon the 
 casting of a die, or equally unpredictable market fluctua- 
 tions. 
 
 The same line of reasoning is applied specifically to ap- 
 preciation in Re Bay State Street Railway Company, 2 
 where the Massachusetts Public Service Commission held 
 that car riders cannot be expected to pay higher fares be- 
 cause land has increased in value or lower fares because it 
 has decreased; that if the company sells its property, it is 
 entitled to whatever profit it makes, but so long as the land 
 is employed in the street-railway business it is dedicated to 
 a public use and held subject to the conditions attaching 
 to such use. 
 
 The Supreme Court has avoided the problem of "un- 
 earned" increment as far as possible. Justice Harlan did 
 not touch upon it in the Ames Case, 3 or in San Diego Land 
 
 1 118 Cal. 556, 50 Pac. 633. 
 
 2 P.U.R. 1916-F-221; 10 Rate Research, 120. See also In re Chicago 
 North Shore Elec. Ry. Co., P.U.R. 1918-A-388. 
 
 * 169 U.S. 466, 18 Sup. Ct. 418, 42 L. ed. 819.
 
 VALUATION OF TANGIBLE PROPERTY 145 
 
 and Town Company v. National City. 1 He concerned him- 
 self primarily with avoiding valuation based upon exces- 
 sive original cost and security issues. Appreciation was not 
 •mentioned in San Diego Land and Town Company v. Jas- 
 per. 2 And the Knoxville Case 3 dealt primarily with depre- 
 ciation. The question was touched upon directly, however, 
 in Willcox v. Consolidated Gas Company, 4 where Justice 
 Peckham said: 
 
 If the property, which legally enters into the consideration of 
 the question of rates, has increased in value since it was acquired, 
 the company is entitled to the benefit of such increase. This is, at 
 any rate, the general rule. We do not say there may not possibly 
 be an exception to it, where the property may have increased so 
 enormously in value as to render a rate permitting a reasonable 
 return upon such increased value unjust to the public. 
 
 This outgrowth of the condemnation analogy and re- 
 production theory, prefaced by the general language as to 
 fair present value, illustrates the confusion in valuation 
 matters. The Court itself realizes that the doctrine cannot 
 be lived up to; that it is a makeshift rule. The danger of bas- 
 ing rates on excessive land values is realized and stated, 
 but the Court is unwilling to break away from the miscon- 
 strued rule of Smyth v. Ames and the reproduction-cost 
 theory. That step was taken, however, in the Minnesota 
 Rate Cases. 5 There the Court, face to face with the injus- 
 tice of applying the reproduction-cost theory when it op- 
 erated to allow a present value based on no actual invest- 
 ment, though still voicing the theory, refused to apply it. 
 It clearly appears, therefore, that the Supreme Court does 
 not consider that a failure to incorporate "unearned" in- 
 crement in the rate-base valuation amounts to a taking of 
 private property within the meaning of the due-process 
 clause of the Fourteenth Amendment. 
 
 1 174 U.S. 739, 19 Sup. Ct. 804, 43 L. ed. 1154. 
 
 2 189 U.S. 439, 23 Sup. Ct. 571, 47 L. ed. 892. 
 8 212 U.S. 1, 29 Sup. Ct. 149. 
 
 4 212 U.S. 19, 52, 29 Sup. Ct. 192, 53 L. ed. 382. 6 230 U.S. 352.
 
 146 FAIR VALUE 
 
 It is proper, however, to consider appreciation to some 
 extent in the reproduction-cost appraisal, for each appraisal 
 must be consistently made in so far as it is possible to do 
 so without violating reason. The reproduction cost of land 
 is the market value of surrounding land of like nature, and 
 that market value in so far as it exceeds the value at the 
 date of original purchase by the utility includes apprecia- 
 tion. 
 
 The State Commissions in the earlier cases, under the 
 influence of the reproduction-cost theory, often allowed 
 appreciated value l in the final valuation, but the tend- 
 ency since the repudiation of reproduction cost as the 
 principal basis of rate valuation has been to exclude ap- 
 preciation. 2 
 
 VIII. The Reproduction-Cost Appraisal 
 
 The preceding consideration of appreciation indicates 
 that since the reproduction-cost appraisal still has a place 
 in valuation, it is necessary specifically to consider its ap- 
 plication to tangible property. In doing so, however, the 
 
 1 State Journal Printing Co. v. Madison G. & E. Co., 4. W.R.C.R. 501; 
 Municipal League v. Pacific G. & E. Co., 21 A. T. & T. Co. Commission 
 Leaflets, 699; Fuhrmann v. Cataract P. & C. Co., 3 P.S.C. 2d Dist.( N.Y.) 
 656; Re Indianapolis Water Co. (Ind.) P.U.R. 1917-E-556; see also 
 Louisville & Nashville R. Co. v. R.R. Comm. of Ala., 196 Fed. 800, 821; 
 Rept. of Committee on Taxes & Valuation, 22d Ann. Rept. of Nat'l 
 Ass'n of Ry. Commrs., 1910, p. 141; 21st Ann. Rept. So. Dakota R.R. 
 Comm. 1910, p. 27; Rept. St. Louis Pub. Service Comm. on Electric 
 Rates, 1911, p. 33; etc. 
 
 2 Western Rate Advance Case, 20 I.C.C. 307, 337; North Coast Water 
 Co. (Cal.) 26 Comm. Leaflets, 1161; see also Rept. Comm. on Valuation, 
 28th Ann. Rept. Nat'l Ass'n of Ry. Commrs., 1916, p. 197. 
 
 Various schemes to avoid rejecting appreciation and yet not include 
 it in the valuation have been developed. Thus, in Steenerson v. Great 
 Northern Ry. Co., 69 Minn. 353, 72 N.W. 713, the return allowed on 
 land values was reduced below that on other elements of value; in 
 Queens Borough Gas & Elec. Co., 2 P.S.C. 1st Dist. (N.Y.) 544, appre- 
 ciation was treated as income; and in Berlin Elec. Light Co., 3 N.H. 
 P.S.C. 174, it was used to offset development expenses. See also Bemis 
 Rept. to Comm. on Gas, Oil & Elec. Light on Chicago Tel. Co., 1912.
 
 VALUATION OF TANGIBLE PROPERTY 147 
 
 limited scope and greatly modified form of the reproduc- 
 tion-cost inventory must be constantly kept in mind. 1 
 
 Reproduction cost is not an end in itself in the rate-mak- 
 ing valuation. It cannot be made the sole basis of final val- 
 uation for that purpose. It is supplemental to the original 
 cost-to-date appraisal and serves as a check upon that 
 theory to determine the actual, justifiable, unimpaired in- 
 vestment. 
 
 The severe criticism of reproduction cost is largely di- 
 rected toward the misuse and misconstruction of the the- 
 ory. It has suffered greatly in the hands of supposedly rep- 
 utable and qualified utility engineers and attorneys. No 
 flight of the imagination has seemed too absurd to offer to 
 the public, provided only that its acceptance would in- 
 crease the rate valuation. Gigantic stock-watering schemes 
 have been concocted under the guise of allowance for con- 
 tingencies, the use of multiples, and unwarranted provi- 
 sion for intangible values. 
 
 Engineers have found it convenient and therefore nec- 
 essary to increase the sums they could reasonably estimate 
 on the basis of tangible property by adding a liberal allow- 
 ance for contingencies 2 to include "all those items which 
 it was impossible to see in making an approximate estimate 
 of work already done" and "any items that may be over- 
 looked." 3 In the Minnesota Rate Cases this padding was 
 
 1 Considerable stress has been placed on the incorporation of the re- 
 production-cost figures in the elements of value enumerated in the Federal 
 Railway Valuation Act. The Act states no specific purpose and requires 
 no final valuation. The reproduction-cost inventory, therefore, has a 
 clear title to consideration. It is in rate-making valuation alone that the 
 reproduction-cost sphere is greatly limited and the Federal Act does not 
 confine itself to the determination of rate value. 
 
 2 In considering contingencies at this point we are guilty of confusing 
 tangible and intangible property, but consideration of the reproduction 
 cost of tangible property cannot well be separated from consideration of 
 parts of the closely related intangible values. 
 
 3 Testimony of Engineer W. L. Darling, Minnesota Rate Cases, Record 
 (N.P.), p. 549. See also the evidence of J. B. Berry, pp. 739, 743; D. C. 
 Morgan, p. 2043; J. F. Stevens (G.N.), p. 445; etc.
 
 148 FAIR VALUE 
 
 fixed at ten per cent, though the appraisers for the road 
 unanimously proclaimed the allowance unjustifiably low. 1 
 In Michigan the same percentage, working against the 
 roads because the valuation was for tax purposes, was 
 equally unanimously proclaimed unjustifiably high. 2 
 
 The engineer for the Commission in the Minnesota Rate 
 Cases suggested five and a half per cent as a fair allowance 
 for contingencies. 3 Mr. Jurgensen, as chief engineer of the 
 Minnesota Commission, allows five per cent. 4 In Wiscon- 
 sin and South Dakota five and one half per cent has been 
 allowed and in Nebraska four per cent. 5 Mr. A. I. Thomp- 
 son, of the Federal Valuation Commission, fixes the proper 
 contingency allowance at from one half of one per cent 
 to two per cent, 4 and the Washington Commission makes 
 no allowance for contingencies. 7 
 
 So far as the final valuation is concerned, the contin- 
 gency allowance must be wholly disregarded. It represents 
 no actual investment. It is clear conjecture, even as to re- 
 production cost. And it merely emphasizes the error of in- 
 cluding appreciation and the value of donated lands. The 
 unavoidable result of the use of such an allowance is a 
 wider separation between fact and theory and greater diffi- 
 culty in establishing successful regulation. 
 
 Mr. R. J. McFall has pointed out that the difference in 
 valuation methods in this one item alone on the estimated 
 $15,000,000,000 worth of railway property in the United 
 States would amount to the difference between $150,000,000 
 and $1,500,000,000. 7 He might, in view of the Washington 
 Commission's stand, have eliminated his minimum figure 
 entirely. The contingency allowance, in other words, seeks 
 
 1 See Record (N.P.), pp. 739-43; 1242-45; and (G.N.) p. 445. 
 
 2 See also 24th Ann. Rept. Nat'l Ass'n Ry. Commrs., p. 35. 
 * Testimony of D. C. Morgan, Record (N.P.), p. 1852. 
 
 4 24th Ann. Rept. Nat'l Ass'n of Ry. Commrs., p. 35. 
 
 6 Senate Report of Valuation, No. 1290, 62d Cong., 3d Sess., p. 172. 
 
 6 2d and 3d Ann. Rept. R.R. Comm. of Washington, p. 43. 
 
 7 Railway Monopoly and Rate Regulation, p. 80.
 
 VALUATION OF TANGIBLE PROPERTY 149 
 
 to credit the railways with $1,500,000,000 in addition to 
 all the value that their engineers have been able to find. 
 
 Not satisfied with this slight increase in value, the engi- 
 neers conceived the idea of increasing gains by applying 
 multiples to all or part of the value they were able and un- 
 able to discover. 1 The justification of multiples has been 
 attempted on the theory that if the property were imagined 
 out of existence and buildings of from two to twenty stories, 
 according to the ambition of the appraiser, were imagined 
 on the land, these visionary buildings would have to be de- 
 stroyed to allow the reconstruction of the property; and on 
 the theory that if the land had to be condemned again these 
 day-dream owners of sky castles would hold out for unrea- 
 sonable figures and the cost of condemnation would mount 
 in algebraic progression. 
 
 There has been no uniform multiple worked out. There 
 has been no agreement as to the amount of the allowance, 
 the conditions under which it is to be made, or the values 
 to which it is to be applied. The courts have not even agreed 
 that the multiple should be used. 
 
 The principle is clearly fallacious. It values property in 
 exactly the same manner that a condemnation proceeding 
 does and then contends that because part of the land may 
 have to be condemned, a higher rate must be allowed for 
 all of it. It fixes a rate base higher than is necessary to at- 
 tract capital into the utility field. If such a valuation were 
 indulged in, the "worth of the service" limitation would 
 force the rate schedule to disregard it. 
 
 1 In Wisconsin "a multiple of one and one half has usually been ap- 
 plied to the market value of railroad land in cities, and in rural districts 
 a multiple of two and one half or three has been used for this purpose. . . . 
 It is said that in Kansas and South Dakota at the present time the mul- 
 tiple ranges from two to five, the average being about three outside the 
 towns." McFall, Railway Monopoly and Rate Regulation, p. 108. See also 
 Rept. Wis. Tax Coram. 1907, p. 274; Rept. Minn. R.R. & Warehouse 
 Comm. 1908, supplement, p. 17. In Texas 25 to 50 per cent was added, 
 in Wisconsin 10 to 150 per cent, in Washington to 500 per cent, and in 
 Nebraska 50 to 225 per cent for increased cost of land for railway use.
 
 150 FAIR VALUE 
 
 Justice Hughes, in considering the use of multiples in the 
 Second Minnesota Rate Cases, said: 
 
 Assuming that the company is entitled to a reasonable share 
 in the general prosperity of the communities which it serves, and 
 thus to attribute to its property an increase in value, still the in- 
 crease so allowed, apart from any improvements it may make, 
 cannot properly extend beyond the fair average of the normal 
 value of the land in the vicinity having similar character. Other- 
 wise we enter the realm of mere conjecture . . . the allowances made 
 below for a conjectural cost of acquisition and consequential dam- 
 ages must be disapproved. 1 
 
 Commissioner Shaw, of Illinois, reviews the question of 
 land values in the light of the Minnesota Rate Cases and 
 states what, it is believed, fairly represents the stand of a 
 majority of the State Commissions of to-day thus: 
 
 Land owned and used for railroad purposes is of a distinctive 
 character. Not a lineal foot of the roadway may be sold without 
 impairment of its functions as a common carrier. . . . There is no 
 difference between a railroad and a street upon which one may 
 travel without charge other than the tolls collected as taxes for 
 the improvements made upon the street, or perchance, for the 
 bonds with which was purchased the land thus dedicated to the 
 public use. But never is it considered that a citizen shall pay more 
 to travel upon a street merely because the lots fronting thereon 
 may have become of great value. The very idea is ridiculous, 
 but it is exactly what the carriers seek when they ask a return 
 upon increased land values. The mere fact that railroads are 
 privately operated affects the matter not at all except to befog 
 the issue. . . . 
 
 A railroad has nothing to sell but transportation and to such 
 sales must it look for its profits. Land enhances in value only be- 
 cause its use may become more intensive. A railroad shares in the 
 general prosperity of a community because, as the population in- 
 creases, the normal use of the carrier's facilities becomes greater 
 and its opportunity to earn more upon the original investment is 
 
 1 230 U.S. 352, 33 Sup. Ct. 729. The use of multiples was rejected for 
 tax valuation in New York, Ontario & Western Ry. Co. v. Shaw, 143 
 N.Y. App. Div. 811, 128 N.Y. Suppl. 177; and in the Rept. on Revalua- 
 tion of Railroads & Canals, N.J., 1911; see also Chicago & Northwestern 
 Ry. Co. v. Smith, 210 Fed. 632.
 
 VALUATION OF TANGIBLE PROPERTY 151 
 
 correspondingly larger. This must be considered the carrier's pre- 
 rogative, rather than the opportunity to include large amounts for 
 land values which the railroad'can never hope to obtain. 1 
 
 The use of multiples to determine land values is expressly 
 rejected. 
 
 Both the multiple and contingency allowance have been 
 excluded from the reproduction-cost appraisal by the 
 weight of opinion in the cases decided subsequent to the 
 Second Minnesota Rate Cases. 
 
 What, then, it may be asked, is the reproduction-cost 
 appraisal of land values to be based upon. The Supreme 
 Court has said market value. It has made this ruling in 
 spite of the general belief that rate valuation must be based 
 primarily upon unimpaired, reasonable investment, and 
 the Court rules correctly. Reproduction cost does not and 
 cannot determine investment, therefore it cannot serve as 
 a rate base. It seeks to determine the investment that would 
 have to be made if the rate base investment had not been 
 made. That figure for land is the market value. The market 
 value includes appreciation, it includes donated land, and 
 it includes reinvested surplus. All these elements admissi- 
 ble or inadmissible for the final valuation are legitimately 
 included in the reproduction-cost appraisal. That is why 
 the claim for a final valuation on the reproduction-cost 
 basis was doomed to failure from the start. Reproduction 
 cost cannot serve to show a final rate value, but it does 
 supplement the original-cost appraisal, serve as a check 
 upon it, and aid greatly in the estimate of value of the 
 service. 
 
 IX. Valuation of Buildings 
 
 Much the same problems that arise in connection with 
 the valuation of land are met with in the appraisal of build- 
 ings. Conjectural allowances by means of "average struc- 
 
 1 Chicago, Milwaukee & North Shore Electric Ry. Co. (111.) P.U.R. 
 1918-A-388.
 
 152 FAIR VALUE 
 
 tures," 1 etc., have been used as short cuts, and the contin- 
 gency allowance has been freely granted. Such practices 
 are less reprehensible here only because the amounts in- 
 volved are smaller. 
 
 The actual investment in building may be determined 
 with comparative ease when the date of construction is 
 known. Prices of material and labor as of the date in issue 
 are readily ascertainable, so the appraisal is reduced to a 
 mere mathematical problem. Where there is no evidence of 
 the date of construction the value of buildings has been 
 fixed by averaging the cost of reproduction new and the 
 actual-cost estimate. 2 
 
 Difficulty is encountered in applying this method of 
 appraisal, however, where existing buildings have been 
 adapted to a use other than that for which they were con- 
 structed. In such cases the worth of the service rendered by 
 the building is clearly not equivalent to the investment 
 therein. The building has depreciated in value for rate- 
 making purposes in addition to its physical depreciation. 
 The investment has been seriously impaired. The worth of 
 the service, being out of harmony with the cost of service 
 if the theory of impaired investment is rejected, predom- 
 inates. Valuation in such case seeks to determine the worth 
 of the service rendered, on the theory that it is equivalent 
 to a fair return upon the unimpaired reasonable invest- 
 ment; and that should the former figure prove the smaller 
 it would necessarily predominate. 
 
 Where a building is used only in part for the utility 
 service or, in case of dual service, for that service in ques- 
 tion, only that portion of the value used and useful in ren- 
 dering the particular service can be included in the rate val- 
 uation. Structures erected far in excess of present needs can 
 be valued only to the extent of the present use; but ade- 
 
 1 Second Minnesota Rate Cases, Record (N.P.), p. 41, 3207-47. Morse, 
 "Valuation by Approximation," Utilities Magazine, Jan. 1914, p. 183. 
 
 2 Taylor v. Northwest Light & Water Co. (Idaho), P.U.R. 1916-A-372.
 
 VALUATION OF TANGIBLE PROPERTY 153 
 
 quate provision may properly be made for growth in the im- 
 mediate future. Buildings owned but not used must be 
 wholly excluded. And all structures must be depreciated to 
 their present value. 
 
 X. Water Rights 
 
 Consideration of water rights seems properly treated in 
 connection with the valuation of tangible property. They 
 are of two types, those rights arising from the ownership 
 of, or easement in, the land, and those based on contract. 
 Consideration of the latter should present few difficulties. 
 
 A valuation for rate-making purposes seeks to determine 
 the reasonable, unimpaired investment. A water-right con- 
 tract which does not create an easement, but simply pro- 
 vides for the purchase and sale of water at a fixed rate, 
 represents no investment. 1 The money paid under such a 
 contract is assumed to represent the fair value of the serv- 
 ice or commodity secured. It is an operating expense, not 
 a capital charge. If it is assumed that payment is made in 
 addition to, or in excess of, the reasonable value of the 
 service, the added expenditure represents an unjustifiable 
 investment not used or useful. Such an investment can- 
 not form a part of the rate base. The savings effected by 
 the contract should secure their reward by way of recog- 
 nition of efficient management in fixing the rate of return. 
 In a purchase-and-sale case such a contract may be prop- 
 erly valued to the extent of its probable effect upon the rate 
 of return, the advantages of operating without a capital 
 investment, and such other similar items as may give it a 
 market value. 
 
 There is, it is true, a line of decisions holding that the 
 advantages from such a contract constitute a value that is 
 properly included in the rate base. 2 It is suggested, however, 
 
 1 Greensburg v. Westmoreland Water Co. (Pa.) P.U.R. 1917-D-478, 
 533. 
 
 2 Bonbrigkt c. Corporation Comm. of Arizona, 210 Fed. 44, reversing
 
 154 FAIR VALUE 
 
 that these cases confuse market value with rate value and 
 may properly be disregarded. 
 
 The case is somewhat different where the utility has pur- 
 chased an easement or acquired riparian rights. Such rights 
 represent an actual investment, an expenditure in advance 
 of receipt of the service and usually not proportionate 
 thereto. They constitute a proper capital charge, 1 to be 
 amortized from income during the life of the right. 
 
 Valuation of this type of water rights has been forcibly 
 made to appear a vexing problem. Most of the difficulties 
 have been introduced by befogging the distinction between 
 original cost, reproduction cost, and final value. The original 
 cost of such water rights, assuming their reasonableness, is 
 the amount actually expended in securing them. The re- 
 production cost is the fair market value of the right or the 
 sum that would have to be expended at the present time to 
 secure the rights. In the case of water rights accruing by 
 reason of ownership of land, the cost of the right is merged 
 in that of the land 2 and the original cost is included in the 
 investment in the property, the reproduction cost is the 
 market value of the land. 
 
 the opinion of the Commission that a contract was not a proper capital 
 charge; City of Ely v. Ely Light & Power Co. (Nevada), 24 Comm. Leaf. 
 578; etc. 
 
 1 San Joaquin & K.R. Canal & Irrig. Co. v. Stanislaus County, 233 
 U.S. 454, 58 L. ed. 1041; Public Service Comm. v. Pacific Power & Light 
 Co. (Cal.) P.U.R. 1915-A-88, 96; Peck v. Indianapolis Lighting & Heat- 
 ing Co. (Ind.) P.U.R. 1916-B-445; Portland R. L. & P. Co. (Or.) 1916- 
 D-976; Apple v. Brazil (Ind.) P.U.R. 1915-C-561; Marin Municipal 
 Water Dist. (Cal.) P.U.R. 1915-C-433. See also Re City of Santa Cruz 
 (Cal.) 1915-F-768, where such value was allowed in a valuation for pur- 
 chase by the municipality. 
 
 2 Re San Lorenzo Water Co. (Cal.) P.U.R. 1915-D-1091; Re City of 
 Redondo Beach (Cal.) 1915-B-429; Campbell v. Hood River Gas & Elec. 
 Co. (Or.) P.U.R. 1915-D-855; Portland Railway L. & P. Co. (Or.) P.U.R. 
 1916-D-976. Percolating and storm waters valued with land, San Gabriel 
 Valley Water Co. (Cal.) 1916-B-895; and Marin Municipal Water Dist. 
 (Cal.) P.U.R. 1915-C-433. The Idaho Commission has used the original 
 method of valuing the land with the water right, Sandpoint Water & L. 
 Co. (Idaho) P.U.R. 1915-F-445, 457.
 
 VALUATION OF TANGIBLE PROPERTY 155 
 
 The final valuation must represent the unimpaired, rea- 
 sonable investment in that portion of the water rights 
 which is used or useful in rendering the public service. Ex- 
 cessive provision for the future must be excluded, and, in 
 the absence of statute to the contrary, undeveloped water 
 power must be disregarded. 1 And where the rights are the 
 result of government franchise only the amount actually 
 expended in developing the rights can be capitalized. 2 
 
 An ingenious scheme to reap rich profits from water 
 rights for power use was developed in the earlier valuation 
 cases. Utility advocates argued that the fair value of a 
 water right was the capitalized saving from the use of water 
 power as compared to steam power. In commenting on this 
 theory, in Grafton County Electric Light and Power Com- 
 pany, 3 Commissioner Niles held that such evidence should 
 not be regarded as important, because the test of value is 
 not the profitable use which can be made of the powers in 
 the particular public service, but the market value of the 
 right, taking into account both supply and demand. To 
 allow any class of property used in the public service to be 
 capitalized at more than its actual market value, the Com- 
 missioner pointed out, would produce the absurd result of 
 establishing for public service corporations a higher basis 
 of capitalization than for corporations of a purely private 
 character. 4 
 
 » Portland Ry. L. & P. Co. (Or.) P.U.R. 1916-D-976. 
 
 2 East Bakersfield Improvement Association v. San Joaquin Light & 
 Power Corp. (Cal.) P.U.R. 1916-C-830. Thayer v. Beaver Valley Water 
 Co. (Pa.) P.U.R. 1916-E-962. 
 
 3 New Hampshire Pub. Serv. Comm. P.U.R. 1916-E-879, 919. 
 
 4 While Re Grafton County Elec. Light & Power Co. is a purchase- 
 and-sale case, the remarks are applicable to the reproduction-cost ap- 
 praisal rate-making, since market value is sought in both instances. The 
 Commission said in part: "We cannot admit that there is any compulsory 
 method of determining the value of a water power. ... Its saving to the 
 owner over some more expensive method of power production does not 
 measure its selling price, or value, any more than the cost-of-reproduction 
 method determines the value of physical structures, simply because, as 
 a matter of fact, water powers are not valued and do not sell upon that
 
 156 FAIR VALUE 
 
 The Vermont Public Service Commission, in considering 
 the saving-over-coal method of valuing water rights in 
 Montpelier and Barre Light and Power Company, 1 disap- 
 proved that method of valuation as a basis for securities 
 issues because it creates a value which may be largely in 
 excess of the actual value of the rights, and when applied 
 to rates deprives the consumer of all benefits from natural 
 resources. 
 
 The Oregon Public Service Commission rejected the sav- 
 ing-over-coal method in Portland Railway Light and Power 
 Company, 2 because the value sought under that theory 
 depends upon a capitalized saving, and the cost of opera- 
 tion varies with the market prices; to measure by this the- 
 ory, therefore, would be to measure with a variable. Its 
 acceptance would deprive the community of one of its 
 
 basis. And the objection of the Supreme Court to the conjectural char- 
 acter of the cost-of-reproduction method applied with equal force to the 
 ' saving-over-coal ' method of valuing water powers. It assumes, what 
 is not proved, that power could be produced profitably by coal. And it 
 assumes, what is not true, that a given amount of power produced by 
 water, varying in amount as it will on even the best regulated streams, is 
 equal in value to a like amount of power generated by steam, constant 
 and reliable at all times. . . . One feature of the ' saving-over-coal' 
 method of determining the value of a water power should not escape 
 attention. We live in a region remote from the coal fields, the cost of trans- 
 portation is heavy, and the price of coal is higher than in almost any other 
 part of the country. On the other hand, ours is a mountainous State, with 
 many streams having a large fall and furnishing an abundance of water 
 power, much of which is still undeveloped. If we adopt the policy of 
 valuing water power in rate and capitalization cases by capitalizing their 
 saving over coal, the people of the State are left subject to all the dis- 
 advantages attendant on remoteness from the coal mines, while enjoying 
 no advantage from living in a region abundantly supplied with water 
 powers." See also Grafton County Electric Light & Power Company 
 (N.H. Sup. Ct.) P.U.R. 1917-E-345, 353; Ocean County Electric Com- 
 pany (N.J.) P.U.R. 1916-D-77; and Berlin Electric Light Company 
 8 N.H. P.S.C. 174; San Joaquin Light & Power Corp. v. Railroad Com- 
 mission (Cal. Sup. Ct.) P.U.R. 1917-E-37, 41; Public Service Commis- 
 sion v. Pacific P. & L. Co. (Wash.) P.U.R. 1916-B-86, 93; Rhinelander 
 v. Rhinelander Lighting Co. 9 W.R.C.R. 406. 
 
 1 P.U.R. 1916-B-973, 976. 
 
 8 P.U.R. 1917-D-962, 971.
 
 VALUATION OF TANGIBLE PROPERTY 157 
 
 natural resources and permit the capitalization of that 
 resource for the sole benefit of an individual. 
 
 The fallacies of the saving-over-coal theory are set forth 
 in the cases cited. It has no proper sphere in valuation. It 
 does not show original cost. It does not determine market 
 value or reproduction cost because it considers only the 
 supply, not the demand side. It is conjectural. And it 
 defeats regulation by granting public service companies 
 a higher basis of capitalization than private industries 
 enjoy. 
 
 XL Pavement over Mains 
 
 The question of capital charges for cutting and replacing 
 pavements over water and gas mains and services and elec- 
 tric ducts plays a comparatively unimportant part in the 
 original-cost appraisal. Only paving actually cut and re- 
 placed in the installation of mains is involved, and the ex- 
 penditures for this work represent necessary and unavoid- 
 able investment. 1 
 
 The reproduction-cost appraisal, however, raises the 
 question of the propriety of allowing in rate valuations for 
 paving not actually cut and replaced, but which would 
 have to be cut if the plant were to be reconstructed under 
 present conditions. The strict theory of the reproduction- 
 cost appraisal if adhered to would include such costs. But 
 for reasons already stated reproduction cost cannot be used 
 without modification for rate valuation even as an appraisal 
 theory. The reproduction cost appraisal is not an end in it- 
 self. It serves only as a check upon and supplement to the 
 original-cost-to-date estimate, not as a substitute for that 
 appraisal. The form of the reproduction-cost appraisal 
 must be fitted to the limitations placed upon its use. The 
 cost of cutting and replacing pavement, therefore, can be 
 included in the estimated cost of reproduction only when 
 
 1 The Commissions' decisions are unanimous in allowing for paving 
 actually cut.
 
 158 FAIR VALUE 
 
 the paving was actually cut. 1 To hold otherwise would in- 
 capacitate the reproduction-cost appraisal for the service 
 it must perform because it would result in figures neither 
 a check upon nor supplemental to original cost. Such 
 figures can have no place in the final valuation. 
 
 Justice Day, of the United States Supreme Court in con- 
 sidering this question in the Des Moines Gas Case, 2 said: 
 
 These pavements were already in place. It may be conceded 
 that they would require removal at the time when it became nec- 
 essary to reproduce the plant in this respect. The master reached 
 the conclusion that the life of the mains would not be enhanced 
 by the necessity of removing the pavements, and that the com- 
 pany had no right of property in the pavement thus dealt with, 
 and that there was neither justice nor equity in requiring the peo- 
 ple who had been at the expense of paving the streets to pay an 
 additional sum for gas because the plant, when put in, would have 
 to be at the expense of taking up and replacing the pavements in 
 building the same. He held that such added value was wholly 
 theoretical, when no benefit was derived therefrom. We find no 
 errors in this disposition of the question. 
 
 This ruling has been followed by all the commissions. 
 
 Cost based on undisturbed paving, despite the claims of 
 reproduction-cost advocates, has no place in a valuation 
 for rate-making purposes. It has been argued, however, that 
 mains laid under pavement are intrinsically more valuable 
 than those in unpaved streets because the greater the extent 
 
 1 The Commissions of California, Illinois, Indiana, Missouri, New 
 York, Ohio, and Wisconsin have repeatedly held that paving not actually 
 cut cannot be included even in the reproduction-cost appraisal. Com- 
 missioner Maltbie, of New York, expressed the State Commission's stand 
 in Mayhew v. Kings County Lighting Company, 2 P.S.C. (N.Y. 1st Dist.) 
 659, thus: "In other words, every time the streets are improved, not only 
 do taxes or assessments go up, but higher gas rates are justified, notwith- 
 standing the fact that the company may not have paid one dollar in con- 
 nection therewith. If this theory is correct, citizens must consider in 
 connection with every civic improvement its effect upon rates for gas, 
 electricity, telephone service, water, transportation, and every other 
 service which involves the use of the subsurface of the streets." 
 
 2 Des Moines Gas Company v. Des Moines, 238 U.S. 153, P.U.R. 1915- 
 D-589, 590, 59 L. ed. 1244.
 
 VALUATION OF TANGIBLE PROPERTY 159 
 
 to which a distribution system is located under paved 
 streets, the greater would be its value, in the eye of a pur- 
 chaser. 
 
 This argument is fallacious in assuming that rate value 
 must include all elements making up purchase value. Rate 
 value attempts to determine value as an element in cost of 
 service, and uncut paving cannot in any conceivable man- 
 ner affect cost of service. The conclusion of the argument is, 
 moreover, as erroneous as the premises. A statement that 
 the value of mains laid under pavement is in general less 
 than that of those over which there is no pavement would 
 probably have been more accurate. Repairs to mains, serv- 
 ices, and ducts become more difficult and costly after pav- 
 ing is laid; connection of services is more expensive; greater 
 time is required for making emergency repairs and improve- 
 ments; property owners having frontage on the street dis- 
 turbed are aggravated; special permits have to be secured; 
 and innumerable similar disadvantages add to the cost of 
 utility service where the mains lie under paved streets. 
 
 The issue is, What is the unimpaired investment in mains 
 upon which the stockholder can reasonably expect a re- 
 turn for his sacrifice. 1 
 
 XII. Summary 
 
 Valuation of the tangible property of a utility for rate- 
 making seeks to determine the actual, reasonable, unim- 
 paired investment in that portion of the tangible property 
 which is used or useful in rendering the public service. Prop- 
 erty acquired without cost cannot be included in the final 
 valuation because it is not investment and represents no 
 sacrifice for which the stockholder is entitled to a return. 
 Property acquired from surplus is properly included in a 
 
 1 It is commonly held that the cost of uncut paving is not a proper 
 charge in a valuation for purchase and sale. Appleton Water Works Com- 
 pany, 6 W.R.C.R. 97, 122, Affd. 154 Wis. 121; Manitowoc Water Works 
 Company, 7 W.R.C.R. 71; Oshkosh Water Works Plant, 12 W.R.C.R. 
 602; etc.
 
 160 FAIR VALUE 
 
 rate valuation, though the Commissions are not agreed 
 upon this point. Land should be valued at its cost in the 
 original-cost appraisal and at the market value of similar 
 neighboring real estate in the reproduction-cost estimate. 
 The final valuation must be premised upon the investment 
 as in the case of other tangible property. 
 
 Buildings upon the land unsuitable for utility purposes 
 and removed add to its value the cost of removal less their 
 salvage value. But the reproduction-cost appraisal must be 
 limited in this regard to actual conditions at the time of 
 purchase to exclude conjectural results and fit the repro- 
 duction-cost estimate to serve as a check upon and supple- 
 ment to the original-cost appraisal. 
 
 Contracts for water service are not capital charges, but 
 easements and water rights vesting with the title to the 
 land are and must be included in the valuation for rate- 
 making or for purchase and sale. Here too the attempt is to 
 determine investment, but the market value of the right is 
 properly included in the reproduction-cost appraisal. The 
 saving-over-coal theory of water-rights valuation is im- 
 proper in all cases. 
 
 Pavement over mains is legitimately valued for rate- 
 making when the pavement was actually cut and properly 
 replaced. But such costs are not properly included, even in 
 the reproduction-cost appraisal where the pavement was 
 laid after the mains were placed. There has been no real in- 
 vestment in such cases and valuation seeks primarily to 
 determine investment.
 
 CHAPTER VII 
 VALUATION OF INTANGIBLE PROPERTY 
 
 I. Overhead Charges 
 
 The most disputed field in public-utility valuation is the 
 allowance for intangible values, and the most mooted ques- 
 tion that of overhead expenses. The bare construction cost 
 of the physical plant and equipment does not include all 
 the justifiable actual capital expenditures of the company. 
 Funds are legitimately spent in prospecting in an under- 
 taking of any magnitude, in determining the possibilities 
 for profit and the risks in the undertaking. The project can 
 seldom be carried out without considerable expenditures 
 for promotion and financing. Engineering and legal advice 
 are always necessary and the fees therefor usually are a 
 proper capital charge. Working capital must be provided. 
 Interest must be paid on the investment up to the time 
 operations are started, taxes must be met, and insurance 
 carried from capital funds till income begins. And there are 
 numerous other similar charges any or all of which may have 
 to be met. Such expenses, when reasonable and not a mere 
 increase in the interest on the funds invested, or a part of 
 the operating expenses, represent actual necessary invest- 
 ment in property used and useful in rendering the utility 
 service, and are properly included in the valuation. 1 
 
 Overhead expenses must be met in the original construc- 
 tion of the plant; but in making the original-cost inventory 
 it is often found that a large part of the expenditures of 
 this nature have been entered on the utility company's 
 books with the physical items to which they attach, as capi- 
 tal or in the operating accounts. In such cases a separate 
 
 1 The State Commission decisions without exception allow for over- 
 head expenses actually incurred in the original-cost appraisal and those 
 reasonably necessary in the reproduction-cost appraisal.
 
 162 FAIR VALUE 
 
 allowance for these items would result in duplication, and 
 create a capital charge representing no actual investment. 
 Aside from liability of duplication, the original-cost ap- 
 praisal presents few difficulties. 
 
 The reproduction-cost estimate, however, raises numer- 
 ous questions as to overhead allowances. It permits in gen- 
 eral of much higher overheads than the original-cost ap- 
 praisal. The items are conjectural, and it seems to be the 
 rule that engineers who submit high valuations of the phys- 
 ical property also surcharge the thus already high appraisal 
 with an undue percentage to cover overhead expenses. The 
 following list of overhead items suggested by an engineer 
 in a case before the Illinois Public Utilities Commission, 1 
 is not exceptional: 
 
 1. Under organization costs — 
 
 (a) Cost of preliminary business investigation and nego- 
 tiations. 
 
 (b) Expert preliminary engineering reports in the gen- 
 eral character and cost of proposed system. 
 
 (c) Incorporation costs including charter fees and cost 
 of issuing and selling stock. 
 
 (d) Legal advice. 
 
 (e) Special engineering investigations for source of wa- 
 ter supply. 
 
 (f) Cost of sinking test wells and pits. 
 
 (g) Cost of determining density of population and of 
 probable motor and light load. 
 
 (h) Cost of optioning real estate. 
 
 (i) Cost of printing and issuing bonds and arranging 
 for their sale. 
 
 (j) And, in general, all cost incident to putting enter- 
 prise on a definite basis up to the point where de- 
 tailed plans can be prepared and actual construction 
 begun. 
 
 2. Under engineering and superintending costs — 
 
 (a) Salaries and expenses of engineering and superin- 
 tending force. 
 
 1 Lincoln v. Lincoln Water & L. Co. Valuation by Maury. I.P.U.C. 
 No. 2496 P.U.R. 1917-B-l.
 
 VALUATION OF INTANGIBLE PROPERTY 163 
 
 (b) Preparation of detailed plans. 
 
 (c) Preparation of specifications. 
 
 (d) Preparation and letting of contracts. 
 
 (e) Setting of lines and grades. 
 
 (f) Inspection of work. 
 
 (g) Estimates for contractors. 
 
 (h) Purchase of material and supervision of labor where 
 
 work is not done by contract, 
 (i) Final tests and adjustment of contracts, 
 (j) The placing of the plant in successful operation. 
 S. Under general administrative and legal costs — 
 
 (a) Salaries of general officers. 
 
 (b) Salaries and expenses of office assistants. 
 
 (c) Cost of accounting. 
 
 (d) Legal advice. 
 
 (e) Rent and office expense. 
 
 4. Under general contingent cost during construction — 
 
 (a) Changes in construction due to unforeseen obstacles 
 developed during the progress of the work. 
 
 (b) Rise in prices of material or labor above normal. 
 
 (c) Financial panics. 
 
 (d) Inclement weather causing delays. 
 
 (e) Floods causing both an actual property loss and un- 
 avoidable delays. 
 
 (f) Failure of contractors. 
 
 (g) Especial unforeseen difficulties encountered in deep 
 excavations. 
 
 (h) Strikes. 
 
 (i) Litigation. 
 
 (j) Taxes and assessments on real estate and personal 
 property for two years. 
 
 (k) Insurance. 
 
 (1) Cost of temporary drive wells and pumping plant 
 to supply the city before the permanent plant is 
 completed, 
 (m) Cost of selling construction bonds, including com- 
 mission or discounts. 
 
 5. Under interest construction — 
 
 (a) Being 6 per cent interest on the moneys expended 
 progressively for construction until the plant begins 
 operation and such charges may be carried in the 
 operating accounts.
 
 164 FAIR VALUE 
 
 It is, of course, inconceivable, even in the face of the 
 serious suggestion of the appraiser, that all these overheads 
 should be encountered in the actual construction of each 
 plant. Clearly all should not be included in the hypothetical 
 reconstruction. An inventory based on possible or even 
 probable overheads rather than those actually encountered 
 would produce the conjectural appraisal rejected in the 
 Minnesota Rate Cases. If it were seriously contended that 
 such overlapping and exaggerated expenses would be actu- 
 ally encountered, the resultant figure would have to be ex- 
 cluded from the rate base in any case, for only the reasona- 
 ble cost can be considered. Mistakes in judgment, unneces- 
 sary duplication, and unwarranted expenditures form no 
 part of the value for rate-making. Such an appraisal would 
 lead to a reproduction-cost appraisal unfit to fulfill its pur- 
 pose in valuation. It should serve as a check upon and sup- 
 plement to the original-cost appraisal, and to enable it to 
 do this the overheads allowed must be based upon fact, 
 not imagination. 1 
 
 It is necessary in determining a reasonable allowance 
 for overhead expenses to consider the general characteris- 
 tics of a property and the efficiency of its operation. Over- 
 head expenses, to a large extent, represent skill, judgment, 
 and ingenuity during the preparatory and construction pe- 
 riod. That skill and judgment should have been paid for in 
 proportion to value received, and would have to be so paid 
 in case of reproduction if the payments were to be properly 
 included in the valuation for rate-making purposes. This 
 is particularly true in regard to engineering and supervision. 
 If the usual fees for such services are to be allowed, the re- 
 sults of the service should be apparent. A five per cent al- 
 lowance seems small, but it must be remembered that a 
 claim for engineering, amounting to five per cent of the total 
 tangible property, is equivalent to a far greater percentage 
 
 1 Herman v. Newton Gas Co. (N.Y. 1st Dist.) P.U.R. 1916-D-825; 
 Mantua Twp. ». New Jersey Gas Co. (N.Y.) P.U.R. 1916-C-163; etc.
 
 VALUATION OF INTANGIBLE PROPERTY 165 
 
 on the items which actually require engineering attention. 
 Five per cent, therefore, is a very remunerative fee for either 
 engineering or supervision. A plant constructed piecemeal 
 during a long period cannot be valued for rate-making with 
 the same allowance for overheads as a plant constructed 
 as a single unit on definitely worked-out plans. Large per- 
 centages for overheads can be allowed only when the prop- 
 erty is very compact, exceptionally efficient, and highly 
 suitable for present-day requirements. 
 | Much of the conjectural element in reproduction-cost 
 appraisals has been needlessly drawn into valuation work 
 by the failure of appraisers to recognize or acknowledge 
 the difference between the appraisal and the estimate; be- 
 tween determining the cost of reproducing a plant of known 
 character under fixed conditions and estimating the cost 
 of producing a plant of similar character. The reproduction- 
 cost appraisal involves no real construction. The whole 
 process is purely imaginary. The items which make up the 
 property are before the appraiser and susceptible of abso- 
 lute determination. The conditions under which those items 
 are to be installed are definitely and exactly prescribed. In 
 the estimate of construction cost the material to be used is 
 conjectural, depending upon unforeseeable contingencies 
 developing during the process of construction. The condi- 
 tions of installation cannot be foretold with absolute accu- 
 racy. The uncertainty involved necessitates a contingency 
 allowance and liberal overheads where actual construction 
 along variable lines is contemplated. Engineers have almost 
 invariably applied estimate methods to the appraisal, and 
 widened the gap between original and reproduction cost. 
 
 In either the original-cost or reproduction-cost appraisal 
 the allowance for overhead must be made upon the depre- 
 ciated value of the property, or the allowance itself be de- 
 preciated to arrive at present value or unimpaired invest- 
 ment. * If such allowances were not depreciated or amortized 
 
 1 Washington & M. R. Co. (D.C.) P.U.R. 1915-B-558; Campbell v.
 
 166 FAIR VALUE 
 
 a capital charge would remain and receive a return from 
 rates after the investment had ceased to be used or useful. 
 Depreciation rather than amortization is the remedy, for 
 the expenditures are a capital charge. 
 
 II. Organization Expenses 
 
 The first overhead charge encountered is organization ex- 
 pense. It includes all the expenditures necessary in bringing 
 about the decision to undertake the enterprise. The law 
 holds the utility responsible for all mistakes in judgment, 
 poor location, over-construction, faulty organization, etc., 
 and allows only a fair rate on a reasonable capitalization 
 irrespective of actual investment. The utility, therefore, is 
 justified in making any reasonable outlay for salaries of 
 officials engaged in bringing men and material into the in- 
 dustry, the preliminary expenses connected with prospect- 
 ing, determination of the demand for service and probable 
 number of consumers, the quality of service desired, ascer- 
 taining operating conditions, availability of water power, 
 fuel, etc., securing options on suitable property, deter- 
 mining the cost of construction, and paying for corporate 
 organization, oflice expenses, legal services, etc. These ex- 
 penditures constitute actual, necessary, and useful in- 
 vestments. The propriety of including such sums in the 
 valuation cannot be questioned. The State Commissions 
 have universally allowed such elements of value. But the 
 California Commission has rejected organization expenses 
 incurred in connection with the building-up of a predecessor 
 company on the ground that such expenses were of no bene- 
 fit to consumers of the existing company. 1 
 
 Hood River G. &. E. Co. (Or.) P.U.R. 1915-D-855; Portland R. L. & P. 
 Co. (Or.) P.U.R. 1916-D-976; Rates of Missouri So. R. Co. (Mo.) P.U.R. 
 1916-C-607; Re Central P. R. Co. (Cal.) P.U.R. 1916-B-845; Re Los 
 Angeles (Cal.) P.U.R. 1916-F-563; Mountain States T. & T. Co. (Col.) 
 P.U.R. 1917-B-198. Contra, see Lima v. Lima T. &. T. Co. (Ohio) P.U.R. 
 1916-E-670. 
 
 1 Salinas City v. Coast Valley Gas & Elec. Co. (Cal.) P.U.R. 1915-B- 
 460.
 
 VALUATION OF INTANGIBLE PROPERTY 167 
 
 III. Promoters' Profits 
 
 Organization costs, however, must be distinguished from 
 promoters' profits. The State Commissions are by no means 
 agreed upon the propriety of including such expenditures 
 in the valuation. There would seem to be little room for dis- 
 pute, so far as the theory of such expenses is concerned, 
 though there is ample room for confusion in practice. The 
 promoter performs a necessary and useful function. With- 
 out his efforts the undertaking would often be impossible. 
 Neither the consumers nor the investors are equipped to 
 perform the promoter's task. If either undertook it, the 
 work would be faultily performed at a greater expense, if 
 accomplished at all; and the resulting organization in nine 
 out of ten cases would be less stable. The promoter assumes 
 risks relatively large and intense. His return must be pro- 
 portionately great. Ability of the highest order, good stand- 
 ing, and financial backing are required and must be paid 
 for. His reward for service and risk represents real invest- 
 ment, beneficial to the company if necessary under the cir- 
 cumstances, whether it was paid for with stock or money. 
 The past, however, has been replete with examples of un- 
 scrupulous, unwarranted if not illegal, promotional specu- 
 lations. A limitation, therefore, must be placed upon such 
 allowances. Promoters' profits can be included in the valua- 
 tion only upon a showing of reasonable necessity and a re- 
 sulting benefit to the service. 1 
 
 IV. Interest during Construction 
 
 A public-utility plant cannot be constructed in any brief 
 space of time. The material and labor must be collected, 
 
 1 Edwards v. Glen Tel. Co. (N.Y. 2d Dist.) P.U.R. 1916-B-940; Bay 
 State Rate Case (Mass.) P.U.R. 1916-F-221; Pine Lawn v. West St. 
 Louis Water & L. Co. (Mo.) P.U.R. 1917-B-679; etc. Such expenses are 
 excluded in case of financing of a subsidiary company by the parent 
 utility. See Herman v. Newton Gas Co. (N.Y. 1st Dist.) P.U.R. 1916-D- 
 825; Chesapeake v. P. Tel. Co. (Md.) P.U.R. 1916-C-925; Mountain 
 States T. & T. Co. (Col.) P.U.R. 1917-B-198; etc.
 
 168 FAIR VALUE 
 
 plans drawn, and months spent in actual construction work. 
 The funds employed in this work draw no return prior to 
 the date of operation. The capital invested is necessarily 
 idle, and produces no return. The investor makes a real 
 sacrifice in foregoing interest during that period, and the 
 interest foregone during construction, organization, etc., 
 up to the time of operation is a necessary and legitimate 
 part of the construction expense. Such charges represent 
 an actual investment, used and useful in the utility busi- 
 ness. They have added to the sale value and the produc- 
 tive value of the property, and the State Commissions, 
 without exception, hold that within reason interest during 
 construction is properly included in the valuation. 
 
 Interest during construction as a capital charge is lim- 
 ited, however, to a reasonable amount. 1 Two issues are 
 presented : 
 
 (1) What is the fair rate of interest? (2) What, under 
 the actual circumstances involved, is the proper length of 
 time during which interest is to be allowed? 
 
 The rate of interest fixed cannot be the same in every 
 case. Even if the current rate under similar risk is accepted 
 as the gauge, the sum will vary in different sections of the 
 country. But that rate cannot properly be accepted as the 
 guide outside the reproduction-cost inventory. The actual 
 rate at which the utility was able to borrow must govern 
 whenever it can be ascertained, and it always can be when 
 notes or bonds were issued. 
 
 The question of the length of time during which interest 
 is to be allowed is equally important in the reproduction 
 inventory. The best that can be produced, and all that the 
 reproduction estimate demands, is a fairly accurate guess. 
 The economist who demands absolute figures to the exclu- 
 sion of all estimates and generalities in the reproduction 
 
 1 Petaluma & S. R.R. Co. (Cat) P.TJ.R. 1915-C-742; Columbia v. 
 Watts Engineering Co. (Mo.) P.U.R. 1915-B-921; Lincoln v. Lincoln 
 Water & L. Co. (111.) P.U.R. 1917-B-l; etc.
 
 VALUATION OF INTANGIBLE PROPERTY 169 
 
 inventory advocates a Utopian appraisal that disclaims 
 all familiarity with actual valuation practice. The repro- 
 duction inventory is an estimate based on supposition, not 
 fact, limited along many lines to prevent too wild flights 
 of fancy, but a guess at best. It claims to be no more. Value 
 is itself but an estimate, and commercial appraisal embraces 
 all the irregularities of regulative valuation. Unquestion- 
 able figures cannot be expected in the reproduction-cost 
 inventory. The length of time necessary to reconstruct the 
 hypothetical plant under arbitrarily assumed conditions 
 at equally arbitrarily averaged prices must be estimated. 
 To make the estimate, a rate of construction must be as- 
 sumed which must in turn be governed by the conditions 
 accepted as prevailing, the size and character of the plant, 
 the surrounding conditions, etc. 1 When the period of con- 
 struction is assumed to be less than a year, it is generally 
 taken for granted that the whole sum needed in the work 
 will be procured before operations are begun -and interest is 
 allowed for the entire construction period. But when the 
 properties are large and the period of plant construction is 
 estimated to extend over several years, it is universally as- 
 sumed that the funds will not all be provided in advance 
 of operations. Actual conditions are approximated by as- 
 suming that half of the money is required for the full con- 
 struction period, or that all of the funds are required for 
 half of that time; and the interest is figured accordingly. 2 
 Six per cent has been a common allowance for interest. 
 
 1 All this guess-work is of course deplorable and would be truly dan- 
 gerous if the reproduction inventory had not been discredited. Yet as a 
 check such an appraisal is valuable. It is on just such estimates as this 
 that purchase and sale are based in the unregulated industrial world, 
 and ordinary cost accounting for price-making rests upon such untrust- 
 worthy valuations. 
 
 2 State Journal Printing Co. v. Madison Gas & E. Co., 4 W.R.C.R. 
 501; Mayhew v. Kings County Lighting Co., 2 P.S.C. (1st Dist. N.Y.) 
 659; Meek v. Consumers' Elec. L. & P. Co. (Mo.) P.U.R. 1915-A-956; 
 Washington & M. R. Co. (D.C.) P.U.R. 1915-B-558; Columbia v. Watts 
 Engineering Co. (Mo.) P.U.R. 1915-B-921; see valuation in Minnesota 
 Rate Cases, 184 Fed. 765; etc.
 
 170 FAIR VALUE 
 
 The rate of interest which the funds accumulated for 
 construction purposes could earn as average balances on 
 deposit against a checking account or certificates of deposit 
 may properly be figured as a set-off against the claim for 
 interest during construction. Such a charge may be esti- 
 mated on the half-year basis in the same manner that the 
 item it is balanced against is computed 
 
 Taxes must be paid on real estate and personal property 
 even before construction work is started. Like interest they 
 constitute a legitimate capital charge, and are properly in- 
 cluded in the valuation x in the amount paid up to the time 
 that operation starts; and they may be cared for as an op- 
 erating expense. The amount of this charge may be com- 
 puted with fair accuracy, even in the absence of complete 
 records, from the local tax rate, capital-stock tax, mortgage 
 tax, etc., all of which may be readily learned. 
 
 Fire, casualty, and other insurance on the plant and 
 equipment during the pre-operating period, like taxes and 
 interest, must be met from capital; and the sums thus ex- 
 pended may properly be included in the valuation as a sac- 
 rifice or necessary investment in property used and useful 
 in rendering the service. 2 
 
 V. Engineering and Superintendence 
 
 The public utility in the process of construction must 
 make multitudinous expenditures for architectural assist- 
 ance and engineering advice, designs, drafts, plans, and 
 the numerous matters involved in construction engineering. 
 The architect must prepare and submit preliminary studies, 
 drawings, specifications, and detailed drawings; and must 
 supervise the work itself. Engineering and superintendence 
 expenditures necessarily begin at the earliest conception 
 
 1 Re Metropolitan St. Ry. Co. Reorganization, 3 P.S.C. (1st Dist. 
 N.Y.) 113; Columbia v. Watts Engineering Co. (Mo.) P.U.R. 1915-B- 
 921; Racine Water Co. (Wis.) P.U.R. 1917-D-277. 
 
 2 Re Metropolitan St. Ry. Co. Reorganization, 3 P.S.C. (1st Dist. N.Y.) 
 113; Roundup v. Roundup Coal Min. Co. (Mont.) P.U.R. 1916-D-393.
 
 VALUATION OF INTANGIBLE PROPERTY 171 
 
 of the undertaking and precede the actual start of construc- 
 tion. They continue until the construction work is com- 
 pleted. The interest of both the investor and the public 
 demand that competent engineering and superintendence 
 service be secured to guarantee efficiency and economy. 
 The reasonable expenditures for these services, therefore, 
 are properly made a part of the regulatory valuation. 1 
 
 Where the original cost of engineering can be ascertained, 
 these figures should control over any hypothetical repro- 
 duction-cost estimate, for they show the real investment. 
 When reproduction cost is sought, resort is had to the per- 
 centage allowance. This method has been severely criticized, 
 but in most cases the critic has lost sight of the fact that 
 the guess occurs in an appraisal which is itself but a guess, 
 and not in the final valuation. The use of percentage allow- 
 ances for these particular items is, in fact, more justifiable 
 than elsewhere, for both architects and engineers in actual 
 practice figure their fees on the percentage basis. The ap- 
 praiser merely substitutes his percentage figures for those 
 of the imaginary engineer. The percentage used by the 
 State Commissions has varied, but it is suggested that the 
 divergency is no greater than that which would appear in 
 actual practice in the figures of several engineers; andregula- 
 
 1 The State Commissions' decisions are unanimous in making allow- 
 ance for reasonable engineering and superintendence charges, but there 
 is some disagreement as to the form of the allowance. The point has been 
 raised that engineering and architectural expenses are not involved in 
 connection with every form of property. See cases excluding engineering 
 expenses on specified items such as furniture, fixtures, tools, teams, 
 meters, etc. Simms v. Columbia Tel. Co. (Mo.) P.U.R. 1915-C-366; Re 
 Racine Water Co. (Wis.) P.U.R. 1917-D-277; Cripple Creek Water Co. 
 (Col.) P.U.R. 1916-C-788; etc. The general percentage allowance, how- 
 ever, has been uniformly applied in a majority of cases because that is 
 the form of engineering and architectural fee actually used in the indus- 
 trial world. While greater accuracy, at first glance, seems available by 
 limiting these charges to the items actually affected, it is doubtful whether 
 such is actually the case. If the reconstruction were real rather than hy- 
 pothetical, the fee would have to be paid on the percentage basis. To 
 estimate on any other basis, therefore, is theoretical and the burden of 
 proving the advantage rests upon the advocate of the change.
 
 172 FAIR VALUE 
 
 tory appraisal on the reproduction-cost theory can scarcely 
 be held to a higher degree of accuracy than industrial valu- 
 ation permits. It must be remembered, too, that if any de- 
 gree of accuracy is to be claimed for the appraisers' estimate 
 the allowance must vary. A much smaller percentage for 
 engineering and superintendence will suffice in the con- 
 struction of a simple plant than in one involving feats of 
 engineering; and an engineer will undertake the work of a 
 large plant on a less percentage than that of a small one 
 because the total figure will be greater. Piecemeal construc- 
 tion and similar conditions must be considered, too, in de- 
 termining the percentage to be allowed, and it may be haz- 
 arded that, all things considered, the determination of the 
 engineering allowance may prove to be the province of the 
 engineer rather than that of the economist. 
 
 VI. Contractors' Profits 
 
 The question of contractors' profits has created more 
 discussion in valuation theories than allowance for promot- 
 ers' profits. The problem does not arise in the original-cost 
 appraisal, for such profits as were incurred are usually 
 merged with the property items and entered on the books. 
 But the reproduction-cost appraisal opens the way for wa- 
 tering accounts through this channel. The appraiser, as- 
 suming that if the plant were to be reconstructed a general 
 contractor would be employed to do the work, creates a ba- 
 sis for application of a contractors'profits percentage to all 
 items. Such a hypothesis may be excusable, in theory, but 
 here as elsewhere the reproduction-cost appraisal must be 
 restrained by the sphere it occupies in valuation. To avoid 
 the charge of being conjectural within the prohibition of 
 the Second Minnesota Rate Cases, the allowance must be 
 limited by the facts of the case. Contractors' profits can be 
 allowed where they were an expense justifiably incurred, 
 i.e., where the utility had reason to believe that it would 
 be more economical for it to let the work out to a contrac-
 
 VALUATION OF INTANGIBLE PROPERTY 173 
 
 tor than to undertake it itself and where it actually did let 
 it out. 1 The general policy of the commissions has been to 
 exclude such expenditures as a separate item. 2 It is not al- 
 ways necessary, customary, or advisable for a utility com- 
 pany to employ a general contractor for its construction 
 work. And it is seldom expedient for the company to re- 
 tain such a contractor throughout the entire construction 
 period. It is customary to construct additions and better- 
 ments and make purchases, after construction is well under 
 way, by dealing directly with the sub-contractors and elim- 
 inating the general contractor's profit. Clearly, therefore, 
 no general contractor's profit allowance can be properly 
 included in the valuation in the absence of direct evidence 
 that such expenditures were incurred and reasonably in- 
 curred. 
 
 When an allowance for contractors' profits is made, it 
 must be based upon a theoretical value reduced from 
 normal by the savings which have made the employment 
 of the contractor justifiable. Such an allowance cannot 
 properly be made where the value approximates the ac- 
 tual construction cost of the plant created without the 
 aid of the contractor, and therefore without the assumed 
 economy. 
 
 VII. Discount on Bonds 
 
 When a public-service company is organized, it is com- 
 monly necessary to secure funds in addition to those de- 
 rived from the sale of stock. This is done by bond issues. 
 And the securities are floated with the aid of an underwrit- 
 
 1 Ocean County Gas Co. (N.J.) P.U.R. 1915-B-601; Washington & 
 M. R. Co. (D.C.) P.U.R. 1915-B-558; etc. 
 
 2 Lincoln v. Lincoln Water & L. Co. (111.) P.U.R. 1917-B-l; Corona 
 v. Corona Home T. &. T. Co. (Cal.) P.U.R. 1915-F-1014; Herman v. 
 Newton Gas Co. (N.Y. 1st Dist.) P.U.R. 1916-D-825; Rept. St. Louis 
 Public Service Comm. on Electric Rates, 1911, p. 45; Metropolitan St. 
 Ry. Reorganization, 3 P.S.C. 1st Dist. N.Y. 113; Berlin Electric Light 
 Company, 3 N.H. P.S.C. 174; etc.
 
 174 FAIR VALUE 
 
 ing firm. The underwriters guarantee to place the securities 
 on the market and dispose of them within a fixed time at a 
 stated price sufficiently below the market price to repay 
 the guarantors for their work. The securities as actually 
 disposed of in such cases are subject to a joint discount, part 
 brokerage, part deferred interest. 
 
 It has been the contention of the utility that brokerage 
 is "the expense necessary to be paid a reputable broker for 
 making a full and complete investigation into the cost and 
 prospects of an inviting public-service enterprise and a rea- 
 sonable compensation for inducing his clientage to invest 
 in well-secured bonds and securities of such corporation," 
 and therefore that it is a necessary expense quite similar 
 to engineering and superintendence and to be valued on 
 the same basis. The State Public Utility Commissions have 
 as a rule adopted a contrary theory. 1 Bond discount, 
 
 1 Public Service Comm. ex rel. Seattle v. Seattle Lighting Co. (Wash.) 
 P.U.R. 1915-B-135; Terminal Taxicab Co. (D.C.) P.U.R. 1915-B-546; 
 Camara de Comercie v. Manila Elec. R. &. L. Co. (P.I.) P.U.R. 1915-D- 
 977; Campbell v. Hood River Gas & E. Co. (Or.) P.U.R. 1915-D-855; 
 Blue Hill St. R. Co. (Mass.) P.U.R. 1915-E-370; Lima v. Lima T. &. T. 
 Co. (Ohio) P.U.R. 1916-E-670; Re Dunham (Mo.) P.U.R. 1916-E-544; 
 Re Citizens' Tel. Co. (Ind.) P.U.R. 1919-B-352; Re Joplin & Pittsburgh 
 Ry. Co. (Mo.) P.U.R. 1919-B-366. 
 
 "Bond discount, constituting a payment for the use of money, is in 
 the nature of an interest payment; that is, it is not 'a proper capital 
 charge, but rather an adjustment of the interest rate to the existing 
 market condition and chargeable to interest account and not capital. 
 The Commission is of the opinion that brokerage and bond discount, 
 are matters to be considered in connection with, and to be reflected in, 
 the rate of return allowed; that such costs should be made up out of in- 
 come by the creation of a sinking fund or reserve sufficient to cover the 
 cost during the life of the bonds, and that therefore such costs should 
 not in equity be considered a part of the cost of reproduction or of the 
 'fair value' to be taken as a base for the fixing of rates." Potomac Elec. 
 Power Co. (D.C.) P.U.R. 1917-D-563; Greensburg v. Westmoreland 
 Water Co. (Pa.) P.U.R. 1917-D-478; Lincoln v. Lincoln Water & Light 
 Co. (111.) P.U.R. 1917-B-l; Chicago, North Shore & Milwaukee Electric 
 R. Co. (111.) I.P.U.C. No. 6186; Pine Lawn v. West St. Louis Water & 
 Light Co. (Mo.) P.U.R. 1917-B-679; City Water Co. (Mo.) P.U.R. 1917- 
 B-624; Lamar v. Intermountain R. L. &. P. Co. (Col.) P.U.R. 1918-B-86; 
 etc. Re Mississippi River & Bonne Terre Ry. Co. (Mo.) P.U.R. 1918-C-
 
 VALUATION OF INTANGIBLE PROPERTY 175 
 
 whether brokerage, deferred interest, or discount, is an 
 interest charge. 
 
 The utility is ordinarily permitted to issue bonds to be 
 sold at a reasonable discount, the amount to be determined 
 by the figure which in the company's judgment is the most 
 advantageous interest rate for the securities under the con- 
 ditions of the money market at the time. The utilities are 
 permitted to exercise judgment in determining what rate of 
 interest will produce the most beneficial results from the 
 financial viewpoint of the particular company. 
 
 If the companies were permitted to capitalize bond dis- 
 counts the valuation would be a mere matter of convenience 
 resting entirely with the utility issuing the bonds, for the 
 amount of discount varies with the interest rate. The lower 
 the interest rate, the greater the rate of discount. A bond 
 bearing a low interest rate and sold at a large discount, cre- 
 ates a greater burden upon the consumer than a bond sold 
 at par with a higher interest rate. If the amount chargeable 
 to the capital account by means of bond discounts were left 
 entirely in the hands of the company, regulation would be 
 nullified. Bond discount represents no proper loss or sacri- 
 fice which can be assessed against the consumers by way 
 of rates. It must be treated as interest, but the commissions 
 have usually taken cognizance of such necessary expendi- 
 tures in determining the rate of return. 
 
 VIII. Piecemeal Construction 
 
 A public-utility plant which has been constructed piece- 
 meal throughout a long period of time by way of extensions 
 and betterments cannot expect an allowance for engineer- 
 ing, architecture, supervision, etc., equal to that of a plant 
 carefully planned and built as a whole. It is contended that 
 such piecemeal construction is more costly than it would 
 
 321. In Omaha & L. R. &. L. Co. (Neb.) P.U.R. 1915-B-416, bond' dis- 
 count was held a proper capital allowance in a valuation for purchase- 
 and-sale purposes.
 
 176 FAIR VALUE 
 
 be if the plant were constructed in one continuous opera- 
 tion. But the added cost is in the physical plant, not in the 
 overhead items. Extensions and betterments are usually 
 planned and carried out by the regular operating force of 
 the utility. Outside engineering, supervision, and manage- 
 ment is not required. 
 
 The original-cost appraisal includes the additional cost 
 of piecemeal construction in the original cost of the equip- 
 ment. It excludes hypothetical allowances for increased 
 overhead items by basing the estimate on actual figures. 
 The reproduction-cost appraisal must allow lower overhead 
 items in case of piecemeal construction, and will admit or 
 reject the increased costs of the physical equipment accord- 
 ing as the estimate is based on present or original construc- 
 tion conditions. The final valuation must approximate ac- 
 tual conditions to determine investment. 
 
 IX. Adaptation and Solidification 
 
 Among the multitude of hypothetical value evils arising 
 from the Pandora-Box valuation in the Minnesota Rate 
 Cases was the question of adaptation and solidification. 
 When a railroad is first constructed the newly made excava- 
 tions wash and slip, the ditches fill from the action of the 
 elements, and the embankments gradually settle. The track 
 superstructure requires constant attention. Lining and 
 dressing of ballasted and unballasted track are necessary. 
 Waterways become clogged and must be opened. Bridges 
 settle and must be put back into line. Station grounds re- 
 quire finishing and improvement. Unused material scat- 
 tered during the construction period must be collected and 
 stored or junked. The finishing touches must be put on the 
 whole equipment and the property placed in orderly con- 
 dition. Actual value results from this work. The mainte- 
 nance charges are materially decreased, wear and tear less- 
 ened, and accidents occur less frequently. And there can 
 be no question but that the work is necessary. Mr. Morgan,
 
 VALUATION OF INTANGIBLE PROPERTY 177 
 
 therefore, included an allowance of twenty per cent in his 
 appraisal to cover these items. The Commission rejected 
 the allowance. 1 
 
 Adaptation, solidification, and seasoning are operating 
 expenses, not capital charges. They involve no sacrifice by 
 the investor. They represent no additional investment or 
 capital outlay as permanent improvements do. They are 
 primarily a maintenance charge; their permanent benefit 
 is wholly incidental. They differ little from ordinary repairs. 
 They must be paid for from revenue the same as worn-out 
 ties, and cannot properly be given a place as capital in the 
 valuation of the property. 2 To allow such charges to be cap- 
 italized for rate-making would force the public to pay the 
 sum so charged as operating expenses, then pay a return 
 upon it as a capital charge, and finally pay the principal 
 again by way of allowance for depreciation. Approval of 
 such a valuation would merely legalize one method of wa- 
 tering capital. 
 
 X. Going Value 
 
 Probably the greatest contest in the valuation field has 
 centered on the question of going value. The utilities in- 
 variably contend that a regulatory valuation must include, 
 in addition to the value of the physical property which is 
 devoted to the public service, a sum alleged to attach itself 
 automatically, barnacle-like, to every "going concern." 
 
 1 Ann. Rep. Minnesota R.R. & Warehouse Comm. 1908, p. 40. 
 
 2 No specific allowance was made for adaptation and solidification in 
 the railroad appraisals of Wisconsin, Michigan, Texas, and South Dakota. 
 Mercantile Trust Co. v. Texas & Pacific Ry. Co., 51 Fed. 529. People ex 
 rel. New York, Ontario & W. Ry. Co. v. Shaw, 143 App. Div. N.Y. 811, 
 128 N.Y. Supp. 177; San Joaquin v. Stanislaus County, 191 Fed. 875; Re 
 Metropolitan St. Ry. Reorganization, 3 P.S.C. (1st Dist. N.Y.) 113; 
 Chicago & Northwestern Ry. Co. v. Smith, 210 Fed. 632; Ann Arbor R. 
 Co. v. Fellows, 236 Fed. 387. Special allowances have been made in 
 Minnesota, Washington, Massachusetts, and Alabama to cover solidifi- 
 cation during construction period, etc. See also Re Tonopah & Tidewater 
 R. Co. (Cal.) 22 A. T. & T. Co. Comm. Leaflets 1064; Re Missouri So. 
 R. Co. (Mo.) P.U.R. 1916-C-G07.
 
 178 FAIR VALUE 
 
 This parasite bases its leasehold rights on the assumption 
 that value accrues irrespective of the purpose of the valua- 
 tion from the fact that the utility is actively engaged in con- 
 ducting a successful undertaking; that it has connected to 
 its mains many buildings and numerous consumers who 
 are purchasing its products; that it possesses an organiza- 
 tion and equipment developed for conducting its business 
 in an efficient manner; that it not only has the capacity 
 to earn but is actually earning; and is a living entity rather 
 than a mere collection of physical assets. 
 
 The claim seems to have had its origin in a tax case de- 
 cided by Justice Brewer in 1894 1 at the time he was strug- 
 gling in the tentacles of the condemnation analogy; and to 
 have been developed in the ill-considered purchase case 
 wherein the United States Circuit Court of Appeals, in an 
 outburst of generosity premised upon ignorance of the lower 
 court's holding, made a double allowance for going value 2 
 in spite of the fact that the utility's franchise had expired 
 and its right to operate as a going concern had ceased. 
 
 The origin of the going-value dispute is thus traceable 
 to purchase-and-sale and tax cases. Here the analogy to 
 condemnation is relatively close. Market value is sought 
 and capitalized earnings may be considered within reason- 
 
 1 Cleveland, Cincinnati, Chicago & St. Louis Ry. Co. v. Backus, 154 
 U.S. 439. 
 
 2 National Water Works Co. v. Kansas City, 62 Fed. 853, 10 CCA. 
 653, 27 L.R.A. 827, 27 U.S. App. 165. The Court found that "the city, 
 by this purchase, steps into possession of a waterworks plant, — not 
 merely a completed system for bringing water to the city, and distribut- 
 ing it through pipes placed in the streets, but a system already earning a 
 large income by virtue of having secured connections between the pipes 
 in the street and the multitude of private buildings. It steps into pos- 
 session of a property which not only has the pledge to earn, but is in fact 
 earning. It should pay therefor not merely the value of the system which 
 might be made to earn, but that of a system which does earn." On this 
 basis the valuation was increased $286,000. The lower court, however, 
 had already valued the property as a going concern and taken into con- 
 sideration existing connections, etc. See statement of Appraisal Com- 
 missioner Moore, vol. 38, Transactions Am. Society of Civil Engineers, 
 p. 151.
 
 VALUATION OF INTANGIBLE PROPERTY 179 
 
 able limits. In such cases the State Commissions have uni- 
 versally held that going value shall be included in the valu- 
 ation, provided it actually exists. 1 But the going value 
 thus allowed in purchase and condemnation cases is dis- 
 tinct from good-will and from franchise value, and it is not 
 always allowed as a separate item. 2 
 
 Several methods of determining going value have been 
 suggested. The utility representatives have suggested nu- 
 merous "rules of thumb" as measures of such value, i.e., a 
 percentage allowance of the appraised value or of the gross 
 annual income, or a definite sum per consumer or inhabi- 
 tant of the territory served. 3 It is apparent that such rules 
 are too indefinite and conjectural to warrant more than 
 passing consideration. There is no direct relation between 
 such measures and a definite going value. They beg the 
 question by assuming that going value must exist, when as 
 a matter of fact it may or may not be present in a given util- 
 ity property. Its determination, when it is present, must 
 be made according to the facts of the particular case and 
 cannot be based on rules of thumb. 
 
 Confusion has been introduced into the dispute by the 
 use of various definitions of the term "going value" by the 
 lower courts and commissions. Four definitions have been 
 generally used. The term has been interpreted as the mere 
 attribute of a utility in normal operation — organized, oper- 
 ating, and engaged in the public service. It has been defined 
 as the difference between the exchange value of the plant 
 and its appraised present value. Going value has been used 
 as synonymous with "good-will" to mean the probability 
 
 1 Omaha v. Omaha Water Co., 218 U.S. 180, 54 L. ed. 991, 30 Sup. Ct. 
 615; Gloucester Water Supply Co. v. Gloucester, 179 Mass. 365, 60 N.E. 
 977; City of Holyoke v. Holyoke Water Power Co., Ann. Rep. Mass. 
 G. & E. Light Commissioners, 1903, pp. 77-82; Galena Water Co. v. 
 City of Galena, 74 Kan. 624, 87 Pac. 735. 
 
 2 Kennebec Water Dist. v. City of Waterville, 97 Me. 185, 54 Atl. 6; 
 Re Monongahela Water Co., 223 Pa. St. 323; etc. 
 
 3 Such arbitrary rules have not been wholly discarded however. See 
 Re Michigan State Tel. Co. (Mich.) P.U.R. 1918-C-81, etc.
 
 180 FAIR VALUE 
 
 of customers continuing to come to the same company for 
 service. And the term has been held to mean the net unrec- 
 ompensed deficits sustained by the company during the 
 development stage of its existence, while operating at a loss. 
 Whether any of these forms of intangible value are present 
 in any particular utility, and represent real unimpaired in- 
 vestment which can be included in the rate valuation, is a 
 question of fact rather than theory. 
 
 XI. Going-Concern Value 
 
 Going value of the first type, the mere attribute of nor- 
 mal operation, has been most widely discussed. 1 It is 
 based upon expenditures made by the utility to secure new 
 business, by way of "free demonstration," "commercial 
 expense," etc. Such charges can be included in an original- 
 cost inventory or the final valuation only when the items 
 of expense were actually incurred and were met from the 
 capital, not the operating account. If the expenditures were 
 not incurred or were cared for as operating expenses, no 
 sacrifice or investment has been made and such charges 
 cannot be included in the valuation. If the expenditures 
 were actually made, but have been repaid by the consum- 
 ers, it is obviously improper to capitalize a duplicate charge 
 against future consumers. Whenever operating expenses 
 are included in the capital account the utility reaps a triple 
 harvest. The investment, if one exists at all, is made by 
 the consumer. He is forced to pay a return to the utility 
 on his own investment, and in the end he must duplicate 
 the investment by depreciation allowances. In addition, 
 unless operating expenses are reduced in direct proportion 
 to the charge to capital, the consumers are compelled con- 
 tinually to repeat this fictitious capitalization to their own 
 everlasting detriment. 
 
 1 Going-concern value has been allowed in Arizona, California, Idaho, 
 Indiana, Kansas, Maine, Maryland, Missouri, Ohio, Washington, Wis- 
 consin, and by the lower Federal Courts.
 
 VALUATION OF INTANGIBLE PROPERTY 181 
 
 The criticism of this form of going value holds true in the 
 reproduction-cost as well as the original-cost appraisal. 
 Any allowance for such expenditures would create a ficti- 
 tious capital charge confusing operating expenses and capi- 
 tal in the assumed reproduction process just as it was in 
 the actual development. 
 
 XII. Going Value and Exchange Differential 
 
 Going value defined as exchange differential l may have 
 a place in valuation for purchase-and-sale cases, provided 
 the excess allowance is amortized from income within a 
 reasonable period, or in valuation for condemnation or tax- 
 ation; but it cannot be considered in a rate-base valuation. 
 Capitalization of an exchange differential merely intro- 
 duces the " vicious circle " whenever the question involved 
 is the fixing of reasonable rates. Earnings are dependent 
 upon rates and if the excess net earnings over a fair return 
 upon a fair value of the property are capitalized as going 
 value, the rates cannot be altered without destroying value. 
 The argument is but a poorly camouflaged attempt to re- 
 establish the rejected market value of the property as a rate 
 base. Such going value has been universally denied by the 
 regulatory commissions. 2 
 
 Going value interpreted to mean the value of the estab- 
 
 1 Camara de Commercio v. Manila Elec. R. &. L. Co. (P.I.) P.U.R. 
 1915-D-977; Am. Water Works Ass'n Proceedings, 1909, pp. 184-279; 
 Trans. Am. Society of Civil Engineers, vol. 73, pp. 326, 354; Valuation of 
 Peoria (111.) Water Works Co. by B. & C. B. Williams, 1910, pp. 11-13; 
 etc. 
 
 2 The argument is stated in the Second Minnesota Rate Cases, 230 U.S. 
 352, 33 Sup. Ct. 729, in a discussion of apportionment of values between 
 interstate and intrastate traffic, thus: "The value of the use, as measured 
 by return, cannot be made the criterion when the return itself is in ques- 
 tion. If the return, as formerly allowed, be taken as the basis, then the 
 validity of the State's reduction would have to be tested by the very rates 
 which the State denounced as exorbitant. And, if the return as permitted 
 ander the new rates be taken, then the State's action itself reduces the 
 amount of value upon which the fairness of the return is to be computed." 
 Fuhrmann v. Cataract P. & C. Co. 3 N.Y. P.S.C. (2d Dist.) 656.
 
 182 FAIR VALUE 
 
 lished business is very similar to going value based upon 
 the exchange differential. It is argued that a utility com- 
 pany which has established a successful business is of far 
 greater value than one possessing only a physical plant 
 without satisfied consumers attached to its distribution 
 system. The income derived from the consumers attached 
 in the one case and not in the other is the only conceivable 
 additional value. If the income derived were not sufficient 
 to pay operating expenses due to unreasonable rates, poor 
 location, or other similar cause, the mere fact that the 
 consumers were attached and willing to accept service at 
 the unremunerative rate would add no value to the equip- 
 ment. The value of the established business is directly de- 
 pendent upon the earnings from the business, is, in fact, 
 synonymous with capitalized net income or prospective 
 income. The interrelationship between rates and such going 
 value necessarily excludes it from consideration in the rate 
 base. 
 
 It is only when the theory and purpose of valuation are 
 completely lost sight of that going value, thus considered, 
 can have any place in the appraisal for rate-making pur- 
 poses. Such value adds nothing to the worth of the service 
 and forms no part of its cost. 
 
 XIII. "Good-Will" 
 
 Going value based on "good- will" has been repeatedly 
 rejected as an element of value for rate-making purposes 
 by the United States Supreme Court. In the Des Moines 
 Gas Case, 1 Justice Day held that: 
 
 The element of "good-will," as applied to the ordinary mer- 
 chant or manufacturer dealing with the public generally, is not 
 considered in estimating the "going value" of complainant's 
 
 1 Des Moines Gas Co. v. Des Moines, 238 U.S. 113, 59 L. ed. 1244. See 
 also Omaha v. Omaha Water Co., 218 U.S. 180, 30 Sup. Ct. 615; Willcox 
 v. Consol. Gas Co., 212 U.S. 17, 29 Sup. Ct. 192, 53 L. ed. 382; and Cedar 
 Rapids G. L. Co. t. City of Cedar Rapids, 223 U.S. 665, 32 Sup. Ct. 389.
 
 VALUATION OF INTANGIBLE PROPERTY 183 
 
 plant. It cannot be considered in a public utility like the one in 
 question in this case, because the complainant has a monopoly 
 of business in which it is engaged in the city of Des Moines, and 
 those who desire to use its products must buy it. . . . That "good- 
 will" in the sense in which that term is generally used as indicat- 
 ing that element of value which inheres in the fixed and favorable 
 consideration of customers, arising from an established and well- 
 known and well-conducted business, has no place in the fixing of 
 valuation for the purpose of rate-making of public-service corpo- 
 rations of this character, was established in Willcox v. Consoli- 
 dated Gas Company. 
 
 Appraisers, however, persist in including "good-will," 
 or its equivalent, in the inventories they submit to the regu- 
 latory bodies, in spite of its unqualified rejection by the Su- 
 preme Court. Capitalization of consumers connected to 
 the mains, of the population served, of the business or- 
 ganization developed, etc., is injected into the appraisal 
 in one form or another irrespective of monopolistic condi- 
 tions. 
 
 Good-will going value is claimed, too, for efficiency in 
 management, competency in supervision, and similar econ- 
 omies. 1 Its advocates argue that exceptionally competent 
 supervision of the undertaking or efficient management of 
 the business produces corresponding financial standing; 
 while incompetent management produces poor financial 
 results. They would require the consumers practically to 
 guarantee competent supervision. Such a stand is untena- 
 ble. The consumers are legally entitled to efficient and ade- 
 quate service and may demand as their right that they be 
 served competently. Public-utility officials are paid from 
 current operating expenses taken from the consumers by 
 way of rates and it must be assumed that their services are 
 rewarded in proportion to the competency of the officials. 
 Neither excellent nor incompetent management can affect 
 capital value for rate-making purposes. The consumer's 
 
 1 See argument of Counsel in Spring Valley Water Works Co. v. San 
 Francisco, 192 Fed. 137.
 
 184 FAIR VALUE 
 
 obligation ends on payment of fair charges for the service. 
 It becomes the utility's duty to conduct its business in a 
 reasonably competent manner when it accepts the con- 
 sumer's payment. Any reward for exceptionally competent 
 supervision or efficient management must be provided by 
 manipulation of the rate of return. 
 
 There is little real argument for including good-will when 
 the purpose of valuation is kept in mind. The object is to 
 determine the cost of service. Good-will adds nothing to the 
 service. Under non-regulated competitive conditions good- 
 will cannot be considered as a cost in price-fixing without 
 transferring it with the sales to the less fortunate competi- 
 tor who has not included it in his price. So long as the owner 
 continues in the undertaking, he has added nothing to his 
 capital stock or to the value of the service he renders or 
 goods he sells. He can secure a return on good-will value 
 only by a sale of his plant or when he enjoys a monopoly. 
 Regulation exists for the express purpose of preventing 
 the latter type of return. 
 
 XIV. The Wisconsin Rule 
 
 Going value based on accrued deficits incurred during 
 the development stage of the utility's operation has received 
 lengthy consideration by many of the courts and commis- 
 sions. The Wisconsin Railroad Commission early devel- 
 oped a method of computing past deficits and surpluses and 
 decided that actual unrepaid early losses should be capital- 
 ized. 
 
 Going value is determined under the Wisconsin method 
 by offsetting annually, for each year since the company's 
 inception, all bona-fide operating expenses, including re- 
 pairs, maintenance, taxes, and depreciation charges, and 
 all return on the investment, against the year's actual gross 
 earnings. Operating expenses often exceed the income, or 
 prove insufficient to provide a reasonable return on the in- 
 vestment and accruing depreciation, during the early years
 
 VALUATION OF INTANGIBLE PROPERTY 185 
 
 of the utility's development. Deficits are thus created which 
 the Wisconsin theory considers as costs properly capital- 
 ized on the same basis as engineering expense, legal fees, 
 and similar expenditures made during the construction 
 period. But the gross annual revenue invariably exceeds 
 the total annual operating expenses and creates an annual 
 surplus above the fair return during the later years of the 
 company's development, unless the project is either poorly 
 conceived or badly managed. The Wisconsin rule balances 
 the total annual surpluses and deficits at the date of the 
 valuation, unless an undue period has passed, and capital- 
 izes any excess of deficits over surplus. The rule, however, 
 works only in the utility's favor, an excess surplus in no 
 way diminishes the capital account. 
 
 The Wisconsin going- value theory seems inherently er- 
 roneous because it necessarily rewards past inefficiencies 
 in management, organization, and plant and equipment. 
 The greater and more numerous the errors of a utility have 
 been in the past, the greater computed going value the 
 utility will receive under this theory. Engineering blunders 
 in the monopolistic utility field may be productive of an 
 unreasonable, or an exceptionally large and remunerative, 
 going value if this theory is strictly adhered to. Poor loca- 
 tion becomes as advantageous as a well-adapted site, save 
 for later operating expenses; and any field may be entered 
 with immunity by the utility irrespective of its present 
 ability to support the undertaking at reasonable rates. Such 
 a valuation theory cannot be accepted for rate-making 
 unless the Commission is willing to disregard the public 
 trust, imposed upon it by law, of keeping rates within the 
 worth of the service. 
 
 Numerous modifications of the Wisconsin rule have been 
 developed by variance in the method of disposing of esti- 
 mated depreciation. Appraisers, in computing a past-defi- 
 cit going value, seldom give the same consideration to de- 
 preciation in the capital account that they do to that same
 
 186 FAIR VALUE 
 
 item in the annual operating-expense account. These tac- 
 tics produce most misleading results. When appraisals thus 
 drafted are gone over and depreciation consistently treated 
 all the way through, the going-value allowance is very fre- 
 quently changed from a net deficit to a net surplus. 
 
 The past-deficit method of determining going value per- 
 mits of two treatments of depreciation in its relation to 
 such value: (1) the capital account may be reduced by an 
 amount identical to that charged against annual deprecia- 
 tion, and extensions and betterments added progressively 
 to capital; or (2) the original capital charge may be pre- 
 served and going value made sufficiently comprehensive 
 to include the depreciation fund and its earnings accumu- 
 lated through the medium of annual charges. 
 
 Looseness and inaccuracy are drawn into the allowance 
 for past deficits by the almost universal failure to consider 
 the accumulation of materials and supplies, working capi- 
 tal, cash surplus, etc., during the years of operation. Such 
 accumulations, if they had been declared as dividends, 
 would have greatly reduced the deficits in the past. Their 
 neglect, in a past-deficit appraisal, operates to pad the cap- 
 ital account. 
 
 XV. The Comparative-Plant Estimate of Going Value 
 
 Closely allied to the valuation of past deficits is the 
 method of estimating going value as the cost of repro- 
 duction of a predetermined income. This method, predi- 
 cated upon the assumption that going value necessarily 
 exists in every public-service plant, is purely hypothetical 
 and conjectural; and is subject to innumerable assump- 
 tions which make it capable of leading to any results the 
 appraiser may wish to reach. 
 
 The comparative-plant method differs from the Wiscon- 
 sin system only by a slight variance in the basic assump- 
 tions. The reproduction method assumes that a new com- 
 pany, the exact counterpart of the existing utility, begins
 
 VALUATION OF INTANGIBLE PROPERTY 187 
 
 operation on the date of the valuation, and that the exist- 
 ing plant ceases to exist, though the environments for util- 
 ity service remain unchanged. An arbitrary period is as- 
 sumed within which surplus will overtake early deficits in 
 the operation of the imaginary corporation. The appraiser 
 then makes a guess as to the amount which the utility 
 would spend in developing the business during that period. 
 The estimate has no foundation in fact. It is a mere guess, 
 worthless as a check upon, or supplement to, the original- 
 cost inventory, and wholly useless in the endeavor to de- 
 termine unimpaired investment. 
 
 Commissioner Niles considers such going value at length 
 in Re Grafton County Electric Light and Power Com- 
 pany, 1 thus: 
 
 The conditions which would exist if the prosperous communi- 
 ties of Lebanon, White River, and Hanover were suddenly de- 
 prived of electricity . . . are unthinkable. No such thing has ever 
 happened. And yet engineers do not hesitate to testify as to just 
 how long it would take these same people, if it did happen, and 
 the plant were reconstructed, to make up their minds that elec- 
 tricity would be a good thing for them, and by intricate calcula- 
 tions to show the exact amount which the company would lose 
 during the time required to "educate" the intelligent citizens of 
 these towns up to that point of appreciation of the value of elec- 
 tricity to which they have already attained. And this it is claimed 
 must be allowed as "going value." 
 
 Of course, the fact is that while the theory of cost of reproduc- 
 tion rests upon the assumption of present conditions in every re- 
 spect except for the non-existence of the plant to be reproduced, 
 when it comes to estimating going value on the basis of deficit 
 from operation in early years the engineers turn their backs on 
 their own fundamental hypothesis, and assume that the inhabi- 
 tants of these towns are as completely ignorant of the use of elec- 
 tricity as they were twenty or twenty -five years ago, when it was 
 first introduced to them. 
 
 There is another absurdity in the reproduction theory which is 
 suggested by the consideration of the developmental period. It is 
 assumed that the plant is to be reconstructed complete as at the 
 
 1 (N.H.) P.U.R. 1916-E-887.
 
 188 FAIR VALUE 
 
 present day, with every extension, not merely to the premises, but 
 into the very houses, including the actual installation of meters, 
 for people who are not going to use the electricity for a period of 
 three or four years after the construction is completed. Such a 
 thing has never been done, and never would be done by sane men. 
 
 The courts and commissions have attached no weight 
 to the hypothetical theories and conjectures of the expo- 
 nents of the reproduction or comparative-plant method of 
 estimating going value. 
 
 XVI. Going Value and the Courts 
 
 There has been great uncertainty in the Commission 
 decisions as to what constitutes going value. The courts 
 have helped little to clear the problem. No definite, exact 
 definition of the term has been attempted. A careful con- 
 sideration of the cases indicates that any element of value 
 which must base its claim for consideration on the increased 
 worth of the property by reason of a well-organized, fully 
 developed, paying business, rather than upon actual unre- 
 paid expenditures made during the development stage of 
 the undertaking, must be excluded from the rate-making 
 valuation. Expenditures actually made during the devel- 
 opment stage of the business, reasonably necessary and 
 never repaid as operating expenses or excessive return (if 
 such are conceivable), might be allowed as going value; 
 though the courts have never stated the necessity of such 
 an allowance. No separate allowance for going value is 
 necessary, and the general practice of the State Commis- 
 sions is to make none. The property must, however, be 
 valued as a going concern. This sounds ambiguous, but it 
 is not. 
 
 Property of a public utility in place but not in use would 
 have only scrap value — less than junk value. The difficul- 
 ties connected with its reclamation would, in places, wholly 
 offset its value. Such valuation of the property would be 
 manifestly unjust for any purpose even after the expira-
 
 VALUATION OF INTANGIBLE PROPERTY 189 
 
 tion of the franchise. Such a valuation for rate-making 
 purposes would clearly violate the due-process clause of 
 the Fourteenth Amendment. To prevent this inequity the 
 courts have held that the property must be valued as a go- 
 ing concern. That holding implies no necessity for a separate 
 allowance for going value. No separate allowance would 
 be possible unless premised on and added to scrap value 
 rather than present value. 
 
 The appraiser instinctively includes such going value 
 in his estimate and considers the plant as a living concern. 
 If this were not true, the only value the appraisal would 
 show would be the scrap or junk value of the physical plant. 
 Such an appraisal could make no allowance for intangible 
 values. An appraisal placing a fair present value on the 
 items inventoried precludes the assumption that the ap- 
 praiser acted upon any other basis than the consideration 
 of the plant as a going concern. 
 
 Any element of going value, other than this general at- 
 tribute which prevents an inequitable dwarfing of invest- 
 ment, must be proven by the utility raising the claim. The 
 burden of substantiating estimated development losses 
 under the title of going value rests upon the utility. 1 Such 
 losses to merit consideration must have accrued during 
 the development or experimental stage, must have been 
 the result of reasonable expenditures by a competent 
 management in a properly located undertaking, and their 
 proof must be accompanied by evidence rebutting the pre- 
 sumption that subsequent profits have repaid the early 
 losses. Losses due to speculation cannot receive considera- 
 tion. 2 
 
 1 Pillsbury v. Peoples Gas Light Co., 4 N.H. P.U.C. 391; Des Moines 
 Gas Co. v. Des Moines, 238 U.S. 113, 59 L. ed. 1244; etc. 
 
 2 The recent decision of the Federal Supreme Court in Denver v. 
 Denver Union Water Co., 62 L. ed. 305, March 4, 1918, while it sustains 
 a separate allowance by the master for going value, does so on the facts 
 of the particular case and adds nothing to the holding in the Des Moines 
 Case. The master's allowance was based on the compulsory operation of
 
 190 FAIR VALUE 
 
 XVII. Franchise Value 
 
 Considerable confusion was drawn into the early valua- 
 tion discussions by a belief that a substantial allowance 
 must be made, even in rate cases, for franchise values. The 
 theory seems to have had its origin in the pestiferous con- 
 demnation analogy, and to have been strengthened by 
 the confusion arising from the attempt to base rates on 
 exchange value, and by the fact that franchise values had 
 been taxed. 1 Numerous theories involving a conjectural, 
 fictitious allowance were advanced, but few received con- 
 sideration. Franchise values are admissible in tax, purchase- 
 and-sale, 2 and condemnation cases, 3 and under certain 
 conditions in rate cases. They are, however, necessarily 
 excluded in the great majority of rate valuations. The ques- 
 tion can be properly approached only by starting with a 
 consideration of the true nature of the franchise. 
 
 The purpose of the franchise is to transfer to individuals 
 the Government's right to conduct what has been denomi- 
 nated a public undertaking. The special privilege of exer- 
 cising part of the State's sovereign powers, namely, the 
 right to use the public highways in a manner imposing an 
 additional burden, and the right to condemn private prop- 
 erty, are transferred by the franchise to the individuals 
 to place them in a position approximating that of the State. 
 The franchise does not increase the value of the property 
 to which it applies. On the contrary, it limits that value 
 
 the utility at a loss under highly unsatisfactory franchise conditions. The 
 decision guards particularly against a duplication of value by the over- 
 lapping of going value and franchise value. The decision contains no 
 mandate that going value must be included as a separate item, provided 
 the property is valued on the going-concern basis. 
 
 1 Spring Valley Water Co. v. San Francisco, 165 Fed. 667, 696; St. 
 Louis, etc., R.R. Co. v. Hadley, 168 Fed. 317; etc. 
 
 2 The State Commissions, without exception, hold that franchise value 
 may be considered in purchase-and-sale cases, because the exchange 
 value of the plant is in question. 
 
 3 Monongahela Navigation Co. v. United States, 148 U.S. 312, 13 
 Sup. Ct. 622, 37 L. ed. 463. The cases are unanimous in allowing fran- 
 chise value in condemnation proceedings.
 
 VALUATION OF INTANGIBLE PROPERTY 191 
 
 by imposing restrictions and burdens upon the property 
 and decreasing the bundle of rights which compose it. The 
 value of the franchise to the utility lies in the fact that it 
 enables the company to go ahead and engage in the under- 
 taking. It changes the plant from an inactive to a live or- 
 ganization. The value thus conferred is allowed in rate- 
 making by appraising the property as a going concern. It 
 cannot be allowed a second time under any alias, however 
 attractive it may sound. 
 
 It cannot be denied that the franchise has value. The 
 State recognizes and taxes such value. But it does not nec- 
 essarily follow that the utility possessing the franchise is 
 entitled to earn a return upon this value. No reasonable 
 interpretation of the franchise can read into it more than 
 a contract to permit the utility to earn a return on its in- 
 vestment in a certain way. The franchise does not increase 
 the investment. It adds no producing power to the property. 
 It forms no part of the elements which make up cost of 
 service, save in so far as it represents actual capital in- 
 vestment. It can have no existence as an element of value 
 apart from the physical property of the utility. 
 
 The public-utility franchise has no counterpart in the 
 industrial plant. The manufacturing business may begin 
 operation at will. If it acquires a monopoly, it subjects it- 
 self to control, but necessitates no franchise grant. Any ad- 
 ditional worth of service developing from the franchise, 
 therefore, must be based upon the public nature of the un- 
 dertaking, the waiving of the public right to conduct it; 
 and, therefore, except in so far as the consideration actu- 
 ally paid for the privilege is concerned, is a sacrifice or in- 
 vestment by the public, not the stockholders, upon which 
 the public alone is entitled to a return. 
 
 The present attitude of the State Commissions toward 
 franchise value is fairly stated by the Wisconsin Railroad 
 Commission in Appleton v. Appleton Water Works Com- 
 pany, 1 thus: 
 
 1 5 W.R.C.R. 215, 281.
 
 199 FAIR VALUE 
 
 The contention often made that the value of franchises should 
 be included as an element for consideration in determining the pres- 
 ent fair value of the active property of a public service corporation 
 for rate-making purposes, though supported by judicial sanction 
 in certain jurisdictions, does not appeal to us as either sound or 
 practical. The only measure of franchise values recognized by the 
 courts is the earning capacity of the property to which the fran- 
 chises give vitality. Earnings are dependent upon the rates that 
 are exacted, and, hence, the higher the rates the more valuable 
 are the franchises, and vice versa. Obviously, therefore, it would 
 be futile to attempt to determine the reasonableness of a rate by 
 any standard which is at all dependent upon franchise values for 
 its dimensions. Such a method of establishing rates would only 
 lead to conjecture and result in no reliable or satisfactory conclu- 
 sion. . . . The concession that a franchise has value and is the sub- 
 ject of property rights does not at all militate against the principle 
 that a franchise is not capable of capitalization for the purpose 
 of exacting of the public charges in excess of what would be re- 
 quired to pay a reasonable return upon the actual reasonable in- 
 vestment. To permit the grantee to capitalize the franchise as 
 against the grantor, would be similar in effect to adding to the 
 consideration for service an additional sum based upon the value 
 of the contract to the party rendering the service. 
 
 Franchise value in rate cases can be allowed only in ex- 
 ceptional cases. The great majority of the public-utility 
 franchises in the United States have been acquired without 
 cost to the stockholders of the companies. They represent 
 no sacrifice or investment upon which a return is necessary. 
 They form no element of production cost. Such value as 
 they have, not forming a cost element, is not within the 
 scope of the due-process limitation upon rate-making. 
 Where the State, however, has specifically and expressly 
 fixed the value of the franchise, and estopped itself by the 
 representation thus made to, and acted upon by, the util- 
 ity, the State cannot destroy the value it has thus created 
 by estoppel. 1 The State has in effect agreed to recognize 
 franchise value to a definite extent as a cost element. The 
 obligation of that agreement cannot be impaired. 
 
 1 Willcox v. Consolidated Gas Co., 212 U.S. 47, 29 Sup. Ct. 192, 53 L. 
 ed. 382.
 
 VALUATION OF INTANGIBLE PROPERTY 193 
 
 Where the public utility has made a reasonable bona-fide 
 expenditure to secure the franchise, the sum so invested 
 in the undertaking may be capitalized. There is, however, 
 no definite holding by a court of last resort that such sum 
 must be included in the valuation. The only case in which 
 its inclusion would seem mandatory would be where the 
 expenditure added to the worth of the service, namely, 
 where it was reasonably necessary, used or useful, and 
 formed a part of the justifiable, as opposed to the actual, 
 cost of the service. The State Commissions, almost with- 
 out exception, include funds expended in good faith 
 in securing franchise privileges; with the qualification, 
 however, that the franchise so secured is used and reason- 
 ably necessary in rendering the service in question. 1 
 
 In tax cases, in purchase-and-sale cases, and in condem- 
 nation proceedings the franchise, in so far as the valuation 
 is not limited as hereinbefore explained by the rate-base 
 value, is valued at its market value based upon duration, 
 earnings, and similar considerations. There has been some 
 dispute in the past concerning the method of determining 
 the market value of the franchise, but the weight of opin- 
 ion now seems to favor the capitalization of earnings based 
 on a reasonable rate for the service performed. 
 
 XVIII. Working Capital 
 
 The appraisal of the tangible and intangible elements 
 thus far considered does not complete the valuation. A 
 utility, to conduct its business, must have a sum for mate- 
 rial and supplies and other working capital in addition to 
 that invested in land, buildings, plant, and equipment. The 
 amount necessary to meet such requirements varies with 
 the working conditions. Coal, oil, coke, ties, poles, wire, 
 material for renewals and replacements, etc., must be car- 
 ried in stock. A reasonable average sum to cover the justi- 
 
 > Petaluma & S. R.R. Co. (Cal.) P.U.R. 1915-C-742; Corona v. Corona 
 Home T. &. T. Co. (Cal.) P.U.R. 1915-F-1014; etc.
 
 194 FAIR VALUE 
 
 fiable investment in such supplies is a proper capital charge 
 and should be considered in the rate-making valuation; 
 providing the property valued constitutes an operating 
 plant. 1 Material and supplies carried for new construction, 
 however, cannot be separately valued if they have received 
 consideration as interest during construction in the allow- 
 ance for overhead. 2 
 
 The company must, in addition to the purchase of sup- 
 plies, pay its employees and distribute its product in ad- 
 vance of the receipts from rates. The bills may not be col- 
 lected for thirty or sixty days. The amount of floating 
 capital necessary to meet current obligations is not sus- 
 ceptible of certain ascertainment. The prevailing practice 
 is to include in the valuation a sum sufficient, in the judg- 
 ment of the commission, under normal conditions to meet 
 and carry the obligations incurred in bills payable prior 
 to receipt of the return from bills receivable. 
 
 XIX. Summary 
 
 In valuation of the intangible elements in the utility prop- 
 erty for rate-making purposes the aim is to ascertain the 
 actual, reasonable, unimpaired investment; irrespective of 
 whether circumstances dictate that the original-cost, re- 
 production-cost, or normal-cost theory of appraisal be given 
 the greater weight. Here, more than anywhere else in valu- 
 ation, the importance of the unimpaired-investment basis 
 of rate-making is apparent. Unless such a base is adopted, 
 the allowance for intangibles becomes a mere conjectural 
 sum predicated upon a guess unlimited save by the modesty 
 or lack of imagination of the appraiser. All semblance of 
 true relationship to cost of production is wiped out. 
 
 Estimates of intangible values must be inaccurate at the 
 
 1 Working capital cannot be allowed in the case of a non-operating 
 company. Petaluma & S. R.R. Co. (Cal.) P.U.R. 1915-C-742. 
 
 2 Mayhew v. Kings County Lighting Company, 2 P.S.C. (1st Dist. 
 N.Y.) 659.
 
 VALUATION OF INTANGIBLE PROPERTY 195 
 
 best. An appraisal which opens the door to unnecessary 
 inaccuracy, by basing estimates upon conjecture and hypo- 
 thetical premises when facts are available, cannot be too 
 severely condemned. 
 
 Actual bona-fide expenditures for reasonable organiza- 
 tion expenses, engineering and superintendence fees, in- 
 terest on a reasonable sum idle during an equitable part 
 of the construction period, insurance, during the construc- 
 tion period, and actual expenditures for franchise privileges 
 have been universally included in the valuation. Discount 
 on bonds is by the weight of opinion considered a form 
 of interest and excluded from the valuation. Contractors' 
 profits and promoters' profits are included when shown 
 to have been actually paid, and to have materially bene- 
 fited the service. Value arising from adaptation and sol- 
 idification has been regarded with suspicion, but included 
 when shown really to constitute a used and useful element 
 in the production of the service. Good-will value is flatly 
 repudiated and going value has been widely rejected as 
 a separate item, but the property has been universally 
 valued as a going concern.
 
 CHAPTER VIII 
 DEPRECIATION 
 
 I. The Theory of Depreciation 
 
 The original-cost appraisal, the reproduction-cost esti- 
 mate, and the normal-cost figures show the actual in- 
 vestment in the utility property. The valuation decides 
 which of these careful guesses, in view of the facts of the 
 particular case, approximates most closely the actual, 
 bona-fide, reasonable investment made by the stockholders 
 in property used and useful in rendering the public service. 
 This figure represents the justifiable sacrifice made by the 
 investors, and the value of the property fair to consumers 
 and stockholders alike. It does not, however, state the 
 "present fair value." It does not show the value of the 
 property assured a return by the due-process clause be- 
 cause actually used in rendering the public service. 
 
 Valuation is resorted to only in the case of plants long 
 in operation. The value of such systems is never the origi- 
 nal investment to date. It is rather the present unimpaired 
 investment. The moment the plant is put in place and op- 
 erations begin, wear and tear starts which immediately 
 diminishes the value, and sooner or later renders the equip- 
 ment useless. Every capital item in the public-utility inven- 
 tory, with the possible exception of land, is a more or less 
 perishable asset. Buildings, plant, fixtures, machinery, 
 leases, patents and contract rights which are limited in 
 duration, distribution systems, rails and rolling stock, all 
 are the prey of depreciation, even though their use may 
 have been slight. Their value is lessened by age, natural 
 decay and the action of the elements, by wear and tear in 
 use, by obsolescence or inadequacy, by accident, and by 
 other similar forces. This unavoidable loss is called "de- 
 preciation."
 
 DEPRECIATION 197 
 
 Depreciation may be defined here as the unavoidable 
 decrease in the value of a perishable asset below its cost; 
 occurring during the period of its use, on account of the 
 action of the forces set forth above. The early cases made 
 a confusing distinction between two general classes of de- 
 preciation, physical and functional. Physical depreciation 
 results from use, or from the exposure of the assets to the 
 elements. Functional depreciation is the result of progress 
 necessitating more efficient appliances or larger capacities 
 for successful operation. There is little difference between 
 the two. Both represent a loss in value due to the lessened 
 life of the equipment. The differentiation is predicated 
 solely on the nature of the agency shortening the life. 
 
 The theory of regulation is that the utility is entitled 
 to earn a fair return upon its reasonable investment and 
 keep that investment unimpaired. Depreciation seriously 
 impairs the investment, and loss from this source is irresist- 
 ible. This loss in value of the equipment is clearly a part 
 of the cost of service. * Service is the element taken, and the 
 payment for that element required by the due-process 
 clause is dependent upon the cost of service. The rate to 
 be reasonable must include every element of cost. Accruing 
 depreciation is undeniably such an element. The utility, 
 therefore, is entitled to secure from rates a sum, in addition 
 to operating expenses and return upon the justifiable in- 
 vestment, which will enable it to offset this loss as it 
 accrues. Both the stockholders and the public suffer if the 
 utility management is remiss in its obligation to collect a 
 fund for replacements, or if the fund collected is not used 
 to counteract the wasting of assets. 
 
 Depreciation has occurred in the case of every operating 
 utility valued. If the depreciation reserve has been collected 
 
 1 Nicholson, Cost Accounting, Theory and Practice, pp. 26, 27; Cole, Cost 
 Accounting for Institutions, p. 46; Ridgway, Cost Accounts, p. 39; Scovell, 
 Cost Accounting and Burden Application, p. 80; Moxey, Principles of Fac- 
 tor Cost Keeping, p. 75; etc.
 
 198 FAIR VALUE 
 
 and is intact, or has been properly used in making replace- 
 ments, the capital is unimpaired. If the fund has not been 
 used to counteract depreciation, but has been paid out in 
 dividends, on the theory that it represented profit, a part 
 of the investment has been withdrawn, is not used in ren- 
 dering the service, and is not within the protection of the 
 due-process clause. The net profit available from earnings 
 cannot be determined before every element of cost of serv- 
 ice is charged against the gross profit. Depreciation is a 
 cost element. It is immaterial whether regulation required 
 the maintenance of a depreciation reserve. The element of 
 manufacturing cost could not be changed by taking advan- 
 tage of a loophole in the law to pay dividends from capital. 
 Depreciation occurred. The value of the equipment was 
 decreased. The company was obligated to make good that 
 decrease or charge a corresponding amount to the capital 
 account. The situation differs in no manner from that in 
 which the company sells outright a portion of its equip- 
 ment and pays out the proceeds as dividends. Accrued 
 depreciation unprovided for lessens the value of the operat- 
 ing plant and is equivalent to a withdrawal to that extent 
 of capital originally invested. 
 
 It is apparent that depreciation presents two distinct 
 problems in valuation work. The appraised value of the 
 property, representing the cost new, must be diminished 
 to show the losses which have already occurred from physi- 
 cal or functional depreciation. And provision must be 
 made to meet the losses which are to occur in the future 
 from those causes, so that the present unimpaired invest- 
 ment may be maintained in statu quo. 
 
 II. Efficiency and Depreciation 
 
 The loss by wear, obsolescence, or accident decreases 
 the value of the plant materially and continuously. It may 
 be a long time after operation starts before repairs or actual 
 replacements become necessary, but the loss in value is
 
 DEPRECIATION 199 
 
 going on all the time. It may not greatly lessen the effi- 
 ciency of the equipment or the quality of the service ren- 
 dered, but, thanks to the utility invocation of the due- 
 process clause, neither efficiency nor quality of service is 
 the object sought. Neither is the basis of fair value. 1 
 Failure to keep this point in mind caused much confusion 
 in the early valuations. Skillful manipulation of the am- 
 biguous word "efficiency," as a middle term in argument 
 leading to the fallacious conclusion that depreciation does 
 not exist in the ordinary plant when maintenance is not 
 slighted, caused the misconception. A similar use of the 
 ambiguous middle term "profit" furthered the deception. 
 Utility appraisals drew a word picture portraying depre- 
 ciation as a sort of Jekyll and Hyde entity, non-existent so 
 far as reduction of value to meet past loss is concerned, but 
 looming genii-large when future loss is considered. 
 
 The utilities sought to establish a distinct line between 
 accrued and accruing depreciation. The significance of 
 their action is apparent. The loss in efficiency in a plant 
 does not occur with the same rapidity as the loss in value 
 resulting from depreciation. The plant may be maintained 
 at practically one hundred per cent efficiency, by apt main- 
 tenance and repairs, and still suffer an accrued depreciation 
 of twenty or more per cent. After comparatively short 
 operation the plant reaches what has been called a state of 
 
 1 The State Commissions have repeatedly held that the fact that the 
 plant is operated at one hundred per cent efficiency does not entitle the 
 company to a plant value of one hundred per cent of condition new in a 
 valuation for rate-making purposes. See Salinas City v. Coast Valleys 
 Gas & El. Co. (Cal.) P.U.E. 1915-B-460; Re Janesville Water Co. (Wis.) 
 P.U.R. 1915-A-178; Lincoln v. Lincoln L. & W. Co. (111.) P.U.R. 1917- 
 B-l; etc. But see, Butler v. Lewiston A. & W. St. R.R. Co. (Me.) P.U.R. 
 1916-D-25; Rich v. Biddeford & S. W. Co. (Me.) P.U.R. 1917-C-982, 
 1000; and Chesapeake & P. T. Co. (Md.) P.U.R. 1916-C-925, holding 
 that the fact that the property has been kept up to a high level of effi- 
 ciency should be considered in ascertaining its depreciation. These de- 
 cisions seem to confuse efficiency and depreciation and attempt to make 
 an allowance by way of depreciation which would ordinarily be cared for 
 in fixing the rate of return.
 
 200 FAIR VALUE 
 
 "average depreciation." The depreciation remains almost 
 stationary at from twenty to thirty per cent of the cost new. 
 The efficiency is maintained at approximately one hundred 
 per cent. The argument made by the utilities has been that 
 past depreciation should be figured on the basis of effi- 
 ciency irrespective of the life of the equipment, but that 
 accruing depreciation should be figured on the basis of the 
 probable additional life. Thus, in the case of a plant op- 
 erating at practically one hundred per cent efficiency there 
 would be no reduction in value due to past loss by wear 
 and tear. Any surplus collected by way of depreciation 
 reserve would be available for dividends. No depreciation 
 having occurred, according to this argument, the entire 
 capital charge of the equipment would have to be spread 
 over the admittedly shortened life of the equipment in order 
 to provide for its retirement at the end of that life. This 
 would increase the percentage of the depreciation allowance 
 and leave a handsome net profit for the manipulator. 
 
 The no-past-depreciation view, perhaps honestly enter- 
 tained, was prevalent in early valuation cases. Many of the 
 engineers employed in valuation work considered any 
 reduction for accrued depreciation an attempt to regulate 
 past profits, in the nature of a confiscation of property, 
 depriving the investor of the return on that part of his 
 investment deducted. The late Henry Floy, in his work on 
 "Valuation of Public Utilities," takes the stand that no 
 depreciation should be deducted from cost new, except 
 perhaps an insignificant sum necessary to keep the plant 
 in a one hundred per cent operating condition. Mr. Hum- 
 phrey, in a paper on "Estimated and Actual Depre- 
 ciation," read before the American Gas Institute, 1 took 
 the same stand. Mr. James Allison, in a report to the 
 St. Louis Public Service Commission, 2 concocts a novel 
 
 1 Proceedings of American Gas Institute, vol. 8, part n, page 521. 
 
 2 Should Public Service Properties Be Depreciated, Sept. 11, 1912. Pro- 
 fessor Allyn Young, in an article on "Depreciation and Rate Control,"
 
 DEPRECIATION 201 
 
 theory wherein he eliminates depreciation by valuing the 
 plant at a "normal" depreciated value and including the 
 loss due to depreciation in the going value as a cost of 
 establishing the business. 
 
 Variation of depreciation methods to meet the conditions 
 in the individual plant is desirable in the case of industrials, 
 but the public-utility accounting requirements are differ- 
 ent. Those elements of public interest which distinguish 
 the utility from other industries necessitate stricter ac- 
 counting methods. Regularity and uniformity of accounts 
 are absolutely necessary to successful regulation. Some of 
 the State Commissions have sought to apply different de- 
 preciation methods to different utilities, but the general 
 attitude of the regulatory bodies is that one system must 
 be rigidly applied to all. The attempt by utility advocates 
 to establish one rate for accrued and another for accruing 
 depreciation has strengthened this attitude. 1 
 
 reprinted from the Quarterly Journal of Economics for August, 1914, took 
 a somewhat similar stand holding that to deduct accrued depreciation 
 from the rate valuation when no depreciation fund had been actually 
 maintained, would merely be a regulation of past profits. Such arguments 
 are clearly based upon a misconception of profits in so far as they do not 
 rest upon a confusion of efficiency and depreciation. 
 
 1 The Illinois Public Utilities Commission states the attitude of regu- 
 latory bodies in general in its Third Annual Report, 1916, p. 120, where 
 it says: "Argument for the adoption of the sinking-fund theory of treat- 
 ing accrued depreciation would be far more convincing were an adherence 
 to the one theory consistently practiced to the exclusion of all other 
 theories. In submitting the question of current or accruing depreciation, 
 it is often argued that the same percentages which have been used for 
 accrued depreciation computed under a sinking fund should be increased 
 somewhat by an allowance for future contingent depreciation. It is this 
 lack of consistency which causes a doubt to arise as to the sincerity 
 of arguments for deduction of accrued depreciation by other than the 
 straight-line method. One rate for depreciation in the properties for the 
 time that has passed, and another rate for the time that is to come, with 
 the date of a rate-making proceeding as the dividing line, is the essence 
 of the question presented. Obviously, the only guide to the future is what 
 has occurred in the past. . . . Rate-regulatory commissions, more and 
 more, are insistent that the subject of depreciation be presented in a fair 
 manner under all circumstances by the public utilities which appear 
 before them; and, above all, the commissions are requiring that utilities
 
 202 FAIR VALUE 
 
 All of these theories are founded upon a confusion of loss 
 of efficiency and depreciation. Such advocates ask that the 
 commissions close their eyes to all existing depreciation and 
 assure the public that property that has been used for more 
 than half its useful life and must soon be replaced is 
 worth the cost new. The argument relies too much upon 
 the credulity of the public. Thorough maintenance, unlim- 
 ited repairs, and careful usage may prolong the life of the 
 equipment, but it cannot wholly counteract the deteriora- 
 tion. It cannot provide for the discarding of equipment to 
 meet unexpected developments in the industry, in the 
 amount of business or the type of machinery. It cannot 
 prevent accidental loss from explosion, fire, storm, etc. It 
 cannot even insure efficiency in the face of such losses. 
 Commissions and courts, with few exceptions, therefore, 
 have ruled against the no-depreciation theories. 
 
 III. Judicial Holdings on Depreciation 
 
 The earlier decisions of the Federal Supreme Court seem 
 
 confused on the question of depreciation. In Union Pacific 
 
 be consistent in the treatment of all angles of the subject." Commissioner 
 Max Thelen of California commented similarly on this point in the Palo 
 Alto Gas Case, 10 Rate Research, 93, saying: "I am becoming increas- 
 ingly impressed with the absolute necessity on the part of all parties of a 
 consistent treatment of the subject of depreciation irrespective of the 
 nature of the particular proceeding which is being considered and of the 
 interest of the parties therein. The Railroad Commission has found in a 
 number of instances that while in rate cases in which it is to the interest 
 of the utility to secure as large an allowance as possible for depreciation 
 annuity, the utility has eloquently presented the need for a large depre- 
 ciation reserve, yet, when it came to the declaration of dividends and the 
 placing of apparent additional value on common stock, the utility has 
 insisted that its property depreciates but very little and that only a 
 small depreciation annuity and depreciation reserve are necessary. Like- 
 wise, we have had instances in which the same utility has claimed a large 
 depreciation annuity in a rate case and later, when its property was being 
 condemned, has claimed that its property is in almost 100 per cent phys- 
 ical condition and that only a small deduction should be made for ac- 
 crued depreciation. It is unnecessary to point out that a utility will gain 
 nothing in the long run with the^public authorities by making such con- 
 flicting claims."
 
 DEPRECIATION 203 
 
 Railroad v. United States 1 the language of the decision was 
 broad enough to include depreciation in the expenses charge- 
 able to earnings in determining net profit. But in United 
 States v. Kansas Pacific Railway Company, 2 decided the 
 same year, no deferred renewals or replacements were al- 
 lowed as a charge against profits. The more recent decisions, 
 however, regard depreciation as a proper charge. Thus, in 
 the City of Knoxville v. Knoxville Water Company, 3 the 
 Court said in part: 
 
 A water plant, with all its additions, begins to depreciate in 
 value from the moment of its use. Before coming to the question 
 of profits at all, the company is entitled to earn a sufficient sum 
 annually to provide not only for current repairs, but for making 
 good the depreciation and replacing the parts of the property when 
 they come to the end of their life. The company is not bound to see 
 its property gradually waste, without making provisions out of 
 earnings for its replacement. It is entitled to see that from earn- 
 ings the value of the property invested is kept unimpaired. ... It 
 is not only the right of the company to make such a provision, but 
 it is its duty to its bond and stockholders, and, in the case of a 
 public-service corporation at least, its plain duty to the public. . . . 
 If, however a company fails to perform this plain duty and to ex- 
 act sufficient returns to keep the investment unimpaired, whether 
 this is the result of unwarranted dividends upon over-issues of 
 securities, or of omission to exact proper prices for the output, the 
 fault is its own. When, therefore, a public regulation of its prices 
 comes under question, the true value of the property then em- 
 ployed for the purpose of earning a return cannot be enhanced 
 by a consideration of the errors in management which have been 
 committed in the past. 
 
 A similar ruling is made in the Consolidated Gas Company 
 Case. 4 These cases were not clear in their inclusion of func- 
 tional depreciation, but this point was cleared by its allow- 
 ance in the Des Moines Water Company Case. 5 
 
 1 99 U.S. 402, 25 L. ed. 274 (1898). * 99 U.S. 459. 
 
 3 212 U.S. 1, 13, 29 Sup. Ct. 149, 53 L. ed. 382. 
 
 4 "Willcox v. Consolidated Gas Co., 212 U.S. 19, 29 Sup. Ct. 192, 53 L. 
 ed. 382. See also Cumberland T. &. T. Co. v. Louisville, 187 Fed. 637, 654. 
 
 5 Des Moines Water Co. v. Des Moines, 192 Fed. 193, 197; affirmed, 
 238 U.S. 153. See also People ex rel. Kings Co. L. Co. v. Public Service 
 Comm., 210 N.Y. 479.
 
 204 FAIR VALUE 
 
 The weight of authority in commission and court deci- 
 sions now requires a reasonable deduction from cost new 
 for accrued depreciation both physical and functional, and 
 an identical treatment in the case of accruing depreciation. l 
 The amount of the depreciation and the method of ascer- 
 taining it, however, have not been fixed by the Court, 
 though there is considerable uniformity as to method in 
 the State Commission practice. 
 
 Computations of depreciation depend upon three ele- 
 ments, the investment, or cost less salvage value, the age, 
 and the life of the asset. The difficulties involved in the 
 depreciation problem are those of the determination of these 
 three elements. The problems presented are those of the 
 engineer. Having found the elements, depreciation becomes 
 an accounting problem. The methods of ascertaining the 
 three depreciation elements have been varied, and confusion 
 has been introduced by confusing the engineering and ac- 
 counting features. 
 
 IV. Salvage Value 
 
 The first issue presented by the depreciation problem is 
 the determination of the cost on which deterioration is to 
 be estimated. As an accounting problem the solution is sim- 
 ple. When a renewal is made, the original cost of the equip- 
 ment retired is removed as an asset, by crediting the plant 
 account, and the cost of the new equipment is entered by 
 debiting that account. The cost of the item retired is re- 
 covered by crediting the depreciation account, and the cost 
 of the new equipment becomes a charge against that ac- 
 count to be amortized within the estimated life of the item. 
 
 1 Accrued depreciation was rejected as unjust to the utility by the 
 Idaho Commission in Sandpoint v. Sandpoint Water & L. Co. (Idaho) 
 P.U.R. 1915-F-445; and Murray v. Public Utilities Comm. (Idaho) 150 
 Pacific 47, P.U.R. 1915-F-436. The Massachusetts Commission refused 
 to deduct for accrued depreciation where the failure to provide a depre- 
 ciation reserve was not due to mismanagement and only meager dividends 
 had been paid. Blue Hill Street R. Co. (Mass.) P.U.R. 1915-E-370.
 
 DEPRECIATION 205 
 
 The original cost of the equipment retired included the 
 cost of installation. The retirement cost includes the simi- 
 lar costs involved in the removal of the equipment, but is 
 decreased by any value of the item as scrap or second- 
 hand equipment. The difference between the scrap value 
 and the cost of removal is the positive or negative salvage 
 value, and must be accounted for before depreciation is 
 figured. The cost which must be amortized is the original 
 cost of the equipment increased or decreased, as the case 
 may be, by the salvage value. 
 
 The original-cost appraisal treats depreciation just as 
 the accountant shows it on the books. The reproduction 
 and normal cost estimates, however, necessarily base depre- 
 ciation on the estimated reproduction or normal cost new 
 plus or minus the estimated salvage value. The final valua- 
 tion is dictated by the appraisal method accepted for the 
 particular case. 
 
 V. Depreciation of Intangibles 
 
 A further question arises as to the sum to be depreciated. 
 Every public-utility inventory, it has been pointed out, lists 
 numerous items representing cost of intangibles properly 
 included in the valuation. The problem is, Shall these values 
 be depreciated as the tangible items of plant and equipment 
 are, or shall they be treated as land and considered free 
 from depreciation? 
 
 Intangible values fall naturally into two classes. Engi- 
 neering, supervision, and similar expenses attach to tangi- 
 ble items and really form a part of the cost of those items. 
 When the tangible property wears out or becomes obsolete 
 and is replaced new, overhead outlays are necessarily in- 
 curred in connection with the replacement. The erection 
 of a new building necessitates architectural fees. The in- 
 stallation of a new boiler involves engineering expense. 
 Such overhead costs serve no useful purpose after the tan- 
 gible assets to which they attach have been replaced. They,
 
 206 FAIR VALUE 
 
 therefore, must be amortized from the depreciation reserve 
 during the life of those assets. 1 
 
 Other intangible costs are of a more general character 
 and cannot be considered a part of the expense of any sin- 
 gle item or class of items of the tangible property. They are 
 incurred only once and form a part of the cost of the com- 
 posite plant. Such elements of value are affected by time 
 only when the life of the whole plant is limited. Ordinarily, 
 they are not depreciated. 2 
 
 Overhead costs which do not seem to fall distinctly into 
 either of these classes, like interest during construction, and 
 taxes and insurance before operation is started, must be in- 
 cluded in the first class and be amortized. 
 
 When depreciation is figured as an arbitrary percentage 
 based on the fair value of the plant and a composite life, all 
 overhead items, of course, must be depreciated. 
 
 VI. Estimated Life 
 
 The difficult problem involved in determining deprecia- 
 tion is the fair estimating of the probable life of the prop- 
 erty. The wasting assets which compose a public-utility 
 plant are of many kinds. The estimated life of each class 
 will be different. The estimated life of each item in the 
 class may vary on account of working conditions, use, etc. 
 Local conditions affect the separate items and the composite 
 life of the plant. The type of construction, the manner of in- 
 stallation, the character of the management, and the policy 
 as to maintenance and repairs materially affect the life of 
 the equipment; and the date of installation, character and 
 adequacy of the equipment installed, are controlling ele- 
 ments, particularly in estimating functional depreciation. 
 The problem, though often forced upon the accountant, is 
 
 1 Portland Railroad L. &. P. Co. (Or.) P.U.R. 1916-D-976; Rates of 
 Missouri Southern R.R. Co. (Mo.) P.U.R. 1916-C-607; Campbell v. 
 Hood River G. &. E. Co. (Or.) P.U.R. 1915-D-855; Chicago & North 
 Shore Elec. R.R. Co. (111.) P.U.R. 1918-A-388. 
 
 2 Lima v. Lima T. &. T. Co. (Ohio) P.U.R. 1916-E-670.
 
 DEPRECIATION 207 
 
 an engineering one involving actual inspection as well as 
 theoretical treatment. 
 
 VII. The Maintenance Plan and Appraisal 
 
 The oldest and perhaps the simplest attempt to meet the 
 depreciation issue was the maintenance plan whereby the 
 consumer was charged for all repairs and renewals of the 
 year. The system was extremely faulty in that during the 
 early part of the estimated life of the wasting asset practi- 
 cally no charge was made, while during the later periods of 
 the life, the asset deteriorated rapidly and excessive pay- 
 ments were required. The system further failed to take into 
 consideration the fact that in spite of maintenance and 
 repairs, assets must eventually be retired and a loss of capi- 
 tal occur. 
 
 Probably the depreciation system next devised was that 
 known as the "appraisal plan." Under this system the ap- 
 praiser inspected the property and estimated, from the ex- 
 amination, the loss due to accrued depreciation. The plan 
 was subject to most of the defects of the maintenance sys- 
 tem, since the wear and tear during the early life of the 
 equipment does not necessarily show proportionately to the 
 degree in which it has actually occurred. 
 
 Neither of these forms of handling the depreciation prob- 
 lem has received the sanction of the public-service com- 
 missions. 
 
 VIII. The Straight-Line Method 
 
 Perhaps the most universally used theory of determining 
 depreciation is the straight-line method. This system, when 
 the estimated life is made with due regard to all known 
 operating conditions, most closely approximates the facts 
 surrounding utility operation and financing; and is thor- 
 oughly consistent, both in the capital account and in the 
 annuities to be set aside from operating expenses. When 
 this method of estimating depreciation is applied, the total
 
 208 FAIR VALUE 
 
 amount to be written off as impaired investment is distrib- 
 uted equally between the periods of the estimated life of 
 the property valued, by dividing the balance between the 
 cost new and salvage value by the estimated life. 
 
 This method of depreciation, though widely enforced by 
 regulatory bodies, has met with considerable opposition 
 from the utilities, on the ground that it does not spread the 
 burden equitably over the estimated life period. The plan 
 assumes that the property depreciates in direct proportion 
 to age, though it is common experience that such is not the 
 case. The argument extended to include maintenance is 
 that already suggested, that immediately following the ac- 
 quisition of the property there is little or no expenditure 
 required for maintenance and repairs, but in the later pe- 
 riods of its estimated life considerable expense is necessary 
 for upkeep. So far as accounting is concerned, the argu- 
 ment continues, the figure which must be evenly spread 
 over the life of the property is the sum of the depreciation 
 charge plus the item of plant maintenance and upkeep. 
 
 This criticism is scarcely justified by practice. In a plant 
 which has been operating any considerable length of time 
 the cost of repairs tends to reach an average annual sum. 
 No two items of equipment wear with exactly the same 
 rapidity. One generator will receive more or harder usage 
 than another. Additions and betterments will change the 
 rates. The result is, the maintenance expense will not vary 
 greatly. Diversity of equipment, therefore, may be relied 
 upon to apportion maintenance charges with comparative 
 equality. So far as plant value is concerned, many engineers 
 contend that the loss is greatest at the start and gradually 
 decreases as the property ages. The benefits of imposing 
 heavy depreciation charges at the start to offset light main- 
 tenance expense in the case of a new plant, on the other 
 hand, are somewhat doubtful inasmuch as the income 
 during the early operating periods is slight and the in- 
 creased burden may prove a real, as well as an unnecessary, 
 hardship.
 
 DEPRECIATION 209 
 
 The criticism of the straight-line method, while perhaps 
 of great weight to the accountant, is entitled to little con- 
 sideration from the regulatory standpoint, for maintenance 
 and upkeep are operating expenses and must be treated in 
 rate-making as wholly distinct from the depreciation charge 
 which, though a cost element, is in the nature of a capital 
 item rather than an expense. The criticism so far as depre- 
 ciation is concerned seems superficially based upon the con- 
 fusion of depreciation and efficiency. The consumers of the 
 service during the early periods of the plant's life benefit 
 from the use of the property fully as much as the consumers 
 who receive service during the later periods. The theory of 
 regulation is that the consumers during each period ought 
 to bear a portion of the total depreciation expense relative 
 to the service they receive from the property valued. This 
 division of cost is accomplished by the straight- line method. 
 
 It has, moreover, the advantages of simplicity, of reason- 
 able conformity to actual conditions, and of allowing the 
 funds to be used for necessary additions and thus to earn 
 a return from the business as well as provide better service. 
 
 IX. The Diminishing- Balance Method 
 
 The criticism of the straight- line method, however, has 
 not been entirely ineffective. A system of estimating de- 
 preciation, known as the " diminishing-balance method," 
 was originated to eliminate the objections made to the 
 straight-line theory. This method makes annual retirances 
 approximate annual depreciation as closely as possible. 
 The depreciation rate under such a system, instead of 
 being a given percentage of cost, is based on the diminish- 
 ing balance of cost less depreciation. A depreciation per- 
 centage is applied to the cost new and the result deducted 
 as the first year's allowance. The same percentage is then 
 applied to the reduced value to ascertain the second year's 
 allowance. The process is repeated during each year of the 
 estimated life until only the salvage value remains unamor-
 
 210 FAIR VALUE 
 
 tized. The percentage under this system must be greater 
 than under the straight-line method when the same amount 
 is to be written off in the same length of time, for the value 
 to which it applies is constantly decreasing. 
 
 The formula of the diminishing-balance method is ex- 
 tremely complicated. The burden of the depreciation is 
 shifted, and becomes much heavier in the early years of the 
 estimated life of the property than in the later period; on 
 the theory that the increased burden in repairs and main- 
 tenance in the later few periods will tend to make the total 
 annual burden substantially the same. The advantages de- 
 rived from this method are theoretical rather than practi- 
 cal. It does not conform to the actual operating conditions 
 in the utility field. It does not spread the burden accord- 
 ing to the benefit received. And it could be successfully 
 applied to accruing depreciation only where it had been 
 honestly carried out with respect to accrued depreciation. 
 The result is that the system has not met with favor from 
 the regulatory commissions. 
 
 X. The Annuity Method 
 
 Another substitute for the straight-line system of esti- 
 mating depreciation is known as the "annuity method." 
 It is premised upon the theory that the cost of production 
 should include not only maintenance, repairs, and depre- 
 ciation, but also the interest on the capital invested in the 
 asset. This method has been universally rejected by com- 
 missions and courts, because in a regulatory programme 
 interest on investment is considered a profit to be cared 
 for by the rate of return rather than an element of cost or 
 a capital asset. It is not in conformity with operating con- 
 ditions. The method is artificial and it writes off a greater 
 amount during the later years of the property's estimated 
 life than during the first years, thus maintaining an inflated 
 value during the early periods of the plant's life and doub- 
 ling the burden on the consumers who have the use of the
 
 DEPRECIATION 211 
 
 depreciated investment, who pay an equal or higher op- 
 erating expense, and who should not pay more than an equal 
 depreciation charge. 
 
 XI. The Sinking-Fund Method 
 
 The sinking-fund method of estimating depreciation has 
 met with unaccountable approval from the utilities, but 
 with corresponding disapproval on the part of courts and 
 commissions generally. 1 It is based on the theory that the 
 amounts set apart for depreciation will be invested at com- 
 pound interest and the returns thus secured added to the 
 reserve. The amount of the depreciation reserve necessa- 
 rily taken from income is thus decreased by the amount 
 of the accumulating interest. The actual provision made 
 for depreciation by this method is lowest during the early 
 years of the estimated life of the property and increases 
 gradually till the retirement. This feature has material ad- 
 vantages. The actual wear and functional deterioration of 
 the property follow much the same increasing line that the 
 reserve does. The loss in efficiency of the property corre- 
 sponds more closely to this plan; and the earnings from the 
 business increase with years in a similar manner. 
 
 Theoretically the sinking-fund method of estimating de- 
 preciation possesses many advantages. Practically it is sel- 
 dom applicable. It can be successfully adopted for accruing 
 depreciation only when it has been carefully applied to ac- 
 crued depreciation and the fund derived therefrom with the 
 accrued interest is intact; 2 or when the actual accrued de- 
 
 1 The Wisconsin and District of Columbia Commissions have recently 
 developed a depreciation method midway between the straight-line and 
 the four per cent sinking-fund theories which has received favorable con- 
 sideration in many quarters. Croty v. Tomah Elec. & Tel. Co. (Wis.) 
 P.U.R. 1917-A-439; Potomac Elec. Power Co. (D.C.) P.U.R. 1917-D- 
 563. 
 
 2 This feature of the struggle to impose the sinking-fund method upon 
 the commissions is clearly dealt with by the Illinois Public Utility Com- 
 mission, thus: " Carrying the illustration one step further, and introducing 
 the assumption that the generator was purchased and installed completely
 
 212 FAIR VALUE 
 
 preciation is computed on the straight-line method, and 
 the sinking-fund method applied to the balance. It creates 
 a non-usable reserve which handicaps maintenance and 
 repairs and makes the system ill-adapted to actual opera- 
 tion with its multitude of contingencies requiring aid from 
 the reserve fund. It assumes that the fund will find ready 
 investment and that the interest it will draw will be unvary- 
 ing, though experience has shown that such is not the case. 
 It withdraws the fund from the business, where under or- 
 dinary conditions it would earn a much larger return than 
 the interest it draws. The most that can be said for the sys- 
 tem is that, under advantageous conditions, it is suscep- 
 tible of a high degree of accuracy. 
 
 XII. Miscellaneous Methods 
 
 One method of estimating depreciation is based upon a 
 periodic revaluation or appraisal of the property. This the- 
 ory has met with little approval because of its cumber- 
 someness and the fact that it does not apportion the bur- 
 den between the consumers of the different periods of the 
 estimated life of the property on any rational basis. 
 
 at a total cost of $10,000, one would arrive at a present value of $5000 
 by the straight-line method and at a present value of practically $6000 
 by the sinking-fund method, after an expiration of ten years of the 20- 
 year life; and, under these conditions, the annuity by the straight-line 
 method is $500 and by the sinking-fund method $336. It is customary for 
 utilities, although they have in no manner during past years provided 
 any depreciation reserve (sinking-fund or otherwise), to ask for $6000 
 in present value and, if they be consistent, $336 for depreciation annuity 
 to replace the generator 10 years later. Thus the utility, by its sinking- 
 fund method, assumes the burden of $4000 in accrued depreciation; but 
 claims a remaining value of $6000, which it is purposed to equalize by 
 annual payment of $336 for the next ten years. A short computation will 
 indicate that ten annual payments, when compounded with interest at 
 five per cent per annum, will yield a total of $4200. Obviously, to insti- 
 tute and follow a sinking-fund theory of depreciation, merely because 
 either a valuation proceeding or a rate case happens to be in progress, a 
 shortage of $1800 (or 18 per cent) in this particular illustration is in- 
 evitable. Similar shortages, in varying amounts, would occur in every 
 item of utility equipment in the entire plant." Third Annual Report 
 Illinois Public Utilities Commission, 1916, p. 118.
 
 DEPRECIATION 213 
 
 Another method is based upon the number of hours in 
 which the property is actually used instead of the estimated 
 life in terms of years or months. The system has some ad- 
 vantages from the cost accountant's viewpoint, but has no 
 distinctive features so far as regulation is concerned. 
 
 There are multitudinous other vari-named methods of es- 
 timating depreciation which merit no specific consideration. 
 
 XIII. The Colorado Theory of Depreciation 
 
 The Colorado Public Utilities Commission has developed 
 a depreciation theory of its own. Accruing depreciation is 
 provided for in the same manner that other commissions 
 handle the question. In the case of accrued depreciation, 
 Colorado recognizes both the "straight-line" and "sink- 
 ing-fund" methods. Both are considered fundamentally 
 correct, and fair to the consumer and the utility alike, when 
 properly applied. The Commission proceeds upon the the- 
 ory that in determining the fair value of the property of a 
 public utility for rate-making purposes no deduction should 
 be made for accrued depreciation on the ground that the 
 property is old, obsolete, inadequate, or otherwise incapa- 
 ble of giving good service. The exclusion from the inven- 
 tory of physical property not used or useful, or not in rea- 
 sonably good service condition and necessary to the opera- 
 tion of the property, is held to counteract sufficiently all 
 loss in value arising from wear and tear, obsolescence, and 
 inadequacy. Where accrued depreciation has been allowed, 
 the Commission has based the deduction on the amount 
 in, or which should have been in, the depreciation reserve; 
 and made a decrease for the purpose of giving the consum- 
 ers the benefit of the earnings from the fund. The Com- 
 mission states its theory in the case of Lamar v. the Inter- 
 mountain Railway, Light and Power Company, 1 thus: 
 
 It seems to the Commission to be self-evident that if the interest 
 earnings on the amounts set aside annually for depreciation are 
 
 1 P.U.R. 1918-13-98, 100.
 
 214 FAIR VALUE 
 
 to be credited to the depreciation reserve, the investor in the prop- 
 erty of the public utility should receive a fair return upon the 
 investment in the property during its useful life, regardless of its 
 physical condition; or, in other words, if the annual depreciation 
 requirement is estimated and set aside on the sinking-fund basis, 
 a deduction on account of depreciation cannot properly be made 
 in arriving at the amount upon which the investors in that prop- 
 erty are entitled to earn a fair return. 
 
 Conversely, it is true that if the annual depreciation require- 
 ment is to be set aside on the straight-line basis — that is, if a 
 sum is to be set aside annually which, without interest accruals, 
 will replace the depreciable property at the end of its life, and, in 
 addition, the consumer is required to pay a fair return on the in- 
 vestment in the property throughout its useful life — the con- 
 sumer will have paid to the utility a sum which will be in excess 
 of a fair return by the combined earnings of the depreciation re- 
 serve. Since, therefore, when the sinking-fund method of providing 
 for depreciation is followed, no deduction on account of deprecia- 
 tion may fairly be made, it follows that, if the reserve is set aside 
 on the straight-line basis, a sum equal to the amount in the depre- 
 ciation reserve, or such an amount as the reserve might reasona- 
 bly have been, had it not been disbursed in the form of dividends, 
 should be deducted in arriving at the fair value of the property 
 for rate-making purposes, otherwise the consumer would be re- 
 quired to pay somewhat higher rates under the straight-line than 
 under the sinking-fund method. 
 
 Conceding, therefore, that fundamentally deduction on ac- 
 count of depreciation should be made for the reason that the 
 consumer is entitled to such amounts as can be earned by the un- 
 expended balance in the depreciation reserve, it follows that de- 
 duction for depreciation should be made to give the consumer the benefit 
 of such earnings, rather than on the theory that an old property is not 
 as valuable for rate-making purposes as a new one. Also, since by 
 the very^nature of a sinking-fund reserve the consumer is auto- 
 matically given the benefit of the earnings of the unexpended bal- 
 ance in the depreciation reserve, it follows that no deduction on 
 account of depreciation may be made when the sinking-fund 
 method is employed. 
 
 The Colorado treatment of depreciation may be justified, 
 but not upon the theory advanced. Such a concept of ac- 
 crued depreciation cannot be reconciled with the cost-of- 
 production basis of valuation. Accrued depreciation is
 
 DEPRECIATION 215 
 
 deducted from cost new to secure the rate base because the 
 investment has been impaired to the extent that deprecia- 
 tion has occurred and no method of treating depreciation 
 can alter this fact. The capital is no longer employed in 
 the public service and, therefore, cannot earn a return. The 
 funds in the depreciation reserve, however, may be em- 
 ployed in a manner that justifies the commissions in adding 
 them to the (depreciated) value of the plant for purposes 
 of rate regulation. When the reserve which should have 
 been held against accrued depreciation has been paid out 
 in dividends, it is not the loss of the interest on the fund 
 which affects the public. There has been an actual with- 
 drawal of investment. The property is no longer within the 
 protection of the due-process clause. To hold otherwise is 
 deliberately to ignore facts and seek justification by confu- 
 sion of efficiency and depreciation. 
 
 When depreciation has been counted on the straight- 
 line method and the assets invested in the securities of 
 other companies, the capital is unimpaired, but the de- 
 preciation funds should not be included in the valuation 
 for rate-making purposes. The assets invested in outside 
 securities are not used or useful in rendering the public 
 service, and therefore have no part in determining the 
 reasonable cost of such service. 
 
 The investment has not been impaired in the case of the 
 sinking fund when the fund is equal to the actual accrued 
 depreciation. The utility has the investment intact. If the 
 investment is held from the business in a sinking fund and 
 the earnings credited to the fund, costs are reduced, the 
 assets in the fund are in a very definite sense used and use- 
 ful to the service, and the company is entitled to receive 
 a return upon them the same as upon any other part of its 
 investment. If, however, the fund is not intact and the 
 money has been devoted to other uses, the utility has in 
 effect elected to secure a return on the money other than 
 that provided by the utility service, and no return can be 
 allowed in the utility rates.
 
 216 FAIR VALUE 
 
 XIV. The Depreciation Reserve 
 
 The proper amount to be held in reserve to meet accruing 
 depreciation is a debated question. The requirements of 
 each type of utility are different. The requirements of indi- 
 vidual utilities of the same type vary greatly. The problem 
 is always a local and an individual one. The uniform sys- 
 tems of accounts drafted by regulatory bodies have for the 
 most part left the question wholly within the hands of the 
 management, providing only against breach of the spirit 
 of the law by the companies. The courts have wisely taken 
 no fixed stand upon the question. It has been widely con- 
 sidered in rate cases, but as an individual problem depend- 
 ent upon the particular facts. 
 
 The nature of the depreciation fund, too, has been a sub- 
 ject of considerable controversy. Some accountants advo- 
 cate a "fund," others a "reserve." Both systems have re- 
 ceived commission sanction, though the weight of authority 
 seems to favor the "reserve." 
 
 The character of the funds held for depreciation was not 
 clearly understood during the early years of regulation, and 
 many utility managers persisted in considering the funds 
 as unrestricted profit available for dividends. The Federal 
 Supreme Court dispelled this view by its decision in Rail- 
 road Commission of Louisiana v. Cumberland Telephone 
 and Telegraph Company. l Reserves held against deprecia- 
 
 1 The Court said, in part: "It was obligatory upon the complainants 
 to show that no part of the money raised to pay for depreciation was 
 added to capital, upon which a return was to be made to stockholders in 
 the way of dividends for the future. It cannot be left to conjecture, but 
 the burden rests with the complainant to show it. It certainly was not 
 proper for the complainant to take the money, or any portion of it, which 
 it received as a result of the rates under which it was operating, and so 
 to use it, or any part of it, as to permit the company to add it to its 
 capital account, upon which it was paying dividends to shareholders. If 
 that were allowable, it would be collecting money to pay for depreciation 
 of the property and, having collected it, to use it in another way, upon 
 which the complainant would obtain a return and distribute it to its 
 stockholders. That it was right to raise more money to pay for depre- 
 ciation than was actually disbursed for the particular year there can be
 
 DEPRECIATION 217 
 
 tion, whatever their form, are a portion of the utility's prop- 
 erty; but they are an encumbered property. The utility 
 holds them in a fiduciary capacity. The money has been 
 collected from the public for a specific purpose which im- 
 poses a sort of trust character upon the reserve. It must be 
 held by the company for the benefit of the public as well as 
 its own interest. The reserve can be used legitimately only 
 for replacement of the wasting assets against which it is 
 held. This does not, however, mean that the money rep- 
 resented by the reserve must be held intact during the 
 interval pending the retirement of the original asset. 
 
 The money shown in the reserve need not constitute an 
 actual, ever-present fund. There is no necessity of keeping 
 the fund in the bank available for momentary use. It should 
 be put to work until the time that it is actually needed. The 
 method of using the fund must be optional with the man- 
 agement, but there would seem to be no better use than 
 that afforded by their reinvestment in the utility business 
 itself under the direct control of the management at a profit 
 as well as interest. A public utility always requires a consid- 
 erable supply of floating or circulating capital. The depreci- 
 ation reserve may be used to meet this requirement, or the 
 funds may be put back into the business gradually by in- 
 vestment in additions and betterments. 
 
 The fact that the actual funds will not be available when 
 needed to make the replacement of the property against 
 which they are held will not be material in either case; pro- 
 vided the investment in additional wasting assets has been 
 restricted to proper capital purchases, and no part of the 
 reserve has been used to meet maintenance requirements 
 or other operating expenses. The money will have been ac- 
 tually invested in the business to meet need for new capital. 
 
 no doubt, for a reserve is necessary in any business of this kind, and 
 so it might accumulate; but to raise more than money enough for the 
 purpose, and place the balance to the credit of capital upon which to pay 
 dividends, cannot be proper treatment." (212 U.S. 414, 424, 53 L. ed. 577.)
 
 218 FAIR VALUE 
 
 The replacement, when it becomes necessary, therefore, 
 may be charged as a new investment because the under- 
 taking now requires an increase in permanent capital. The 
 plant, however, must be valued for rate-making purposes 
 at its depreciated value to make this use possible. Thus in 
 the case of a plant, the original investment on which was 
 $10,000, with accrued depreciation of $2000, at the date of 
 valuation, the present worth would be $8000. If the money 
 had been withdrawn from the depreciation fund and used 
 for additions and betterments, the present worth would be 
 increased to $10,000. If the plant was carried on the books 
 at the original cost and the investments made from the de- 
 preciation fund had been capitalized, there would be a capi- 
 talization of $12,000 as opposed to a present worth of only 
 $10,000. Such a condition could not be recognized in a valu- 
 ation for regulatory purposes; but it could be avoided either 
 by valuing the property at its depreciated value, or by re- 
 fusing to capitalize the assets acquired by investment of 
 the depreciation fund. 
 
 The money represented by the depreciation fund cannot 
 be capitalized irrespective of the use made or to be made 
 of it, unless the money is set aside as a specific fund and 
 its earnings added to that fund as they accrue, because the 
 investment back of the fund has been withdrawn from the 
 business and is not used or useful in rendering the service. 1 
 
 XV. Summary 
 
 In valuing the property of a public utility for rate-making 
 purposes the aim is to determine the present, unimpaired 
 investment. There is no longer any denial that depreciation 
 takes place. Both physical and functional depreciation 
 are considered. It is immaterial what force has caused the 
 loss in value, so long as there has been an impairment of 
 investment. The loss is primarily that of the public. The 
 utility is unquestionably entitled to collect the fund from 
 1 Valley Natural Gas Co. (Cal.) P.U.R. 1918-C-l, 3; etc.
 
 DEPRECIATION 219 
 
 the consumers to keep the property intact. If, however, 
 the utility fails to collect such a fund, or collects it and pays 
 it out as dividends, or collects it and devotes it to a use 
 other than the replacement of the wasting assets against 
 which it is held, a part of the original investment has been 
 withdrawn from the public service and devoted to another 
 use. If the fund is collected, held intact, and credited with 
 its earnings, it represents a legitimate investment which is 
 made to assure continuous adequate service. In such cases 
 it must be allowed to earn a return from the utility rates. 
 
 The proper amount of the reserve is a question of fact 
 to be determined by the circumstances in each case. No 
 two companies will necessarily be best served by the same 
 depreciation figure. 
 
 The expedient method of determining depreciation is to 
 some extent a question to be answered by the circumstance 
 of the particular case. The straight-line method, however, 
 has been found most widely applicable and has been 
 adopted by a majority of the commissions.
 
 CHAPTER IX 
 THE RETURN ON THE INVESTMENT 
 
 I. Valuation and the Rate of Return 
 
 It may seem out of place, in a treatise on "fair value," 
 to consider the rate of return to be allowed upon the rea- 
 sonable investment shown by the valuation; but valuation 
 and return are so interdependent in rate-making that nei- 
 ther can be satisfactorily considered separately. 
 
 The determination of the "fair value" of a public utili- 
 ty's property, in the great majority of cases, has been a step 
 in the longer process of determining the reasonableness of 
 rates. The limitation imposed upon legislative rate-making, 
 by the application of the due-process clause of the Four- 
 teenth Amendment to rate control, placed public-utility 
 regulation on a cost-of-production basis. Modern rate con- 
 trol involves the fixing of rate schedules. So long as the rate 
 fixed is a "reasonable" one, the State acts within its police 
 power and the control is legitimate. When rates are fixed 
 below the point which allows the utility to earn a fair re- 
 turn on its reasonable investment in property used and use- 
 ful in the public service, the rates are not "reasonable." 
 The power of eminent domain, not the police power, has 
 been exercised in such cases. The State has passed a law 
 which, if enforced, would take service for the public use, 
 to the value of the difference between the rate fixed and the 
 fair worth of the service which would be rendered. The law 
 is unconstitutional because it contains no provision for pay- 
 ment for the property which would be taken if the law were 
 enforced. 
 
 A reasonable rate, under this forced construction of 
 due process, consists of several elements. It must give to 
 the utility cost of service, plus interest on investment, plus
 
 THE RETURN ON THE INVESTMENT 221 
 
 profit. Valuation determines the first of these elements. 
 The rate of return determines the second and third. 
 
 II. The Development of the Return Question 
 
 The decisions of the Supreme Court relative to the fair 
 rate of return show the same gradual change that marked 
 the development of the valuation doctrine. They started 
 with the holding in the Granger Cases that the Court is 
 without jurisdiction to consider legislative-made rates at 
 all. The development of the doctrine of judicial review 
 brought the question of rate reasonableness, and with it 
 the return issue, to the front. The early cases did not seem 
 to detect the necessary connection between return and rea- 
 sonableness. The Court was feeling its way. The justices 
 doubted their power to question legislative judgment. Any 
 return above operating expenses and depreciation which 
 the legislature might deem expedient was considered suffi- 
 cient. The Court seemed unwilling to interfere. 
 
 The question of return came before the Court specifically 
 first in Reagan v. Farmers' Loan and Trust Company, 1 
 wherein Justice Brewer said: 
 
 It is unnecessary to decide, and we do not wish to be understood 
 as laying down an absolute rule, that in every case a failure to 
 produce some profit to those who have invested their money in 
 the building of a road is conclusive that the tariff is unjust and 
 unreasonable. And yet justice demands that every one should re- 
 ceive some compensation for the use of his money or property, if 
 it be possible without prejudice to the rights of others. 
 
 The Court then proceeded to point out that there may be 
 circumstances justifying rates which produce no return 
 for the operator on account of extravagant expenditures, 
 waste in management, unjustifiable salaries, poor judg- 
 ment in location or time of construction, etc. 
 
 The issue was presented next in Stanislaus County v. 
 San Joaquin and Kings River Canal and Irrigation Com- 
 1 154 U.S. 362, 14 Sup. Ct. 180, 38 L. ed. 1014.
 
 222 FAIR VALUE 
 
 pany, 1 wherein the Court held that it was not confis- 
 cation, nor denial of equal protection of the laws, to fix 
 water rates which would produce a return of six per cent 
 upon the value of the property actually used in rendering 
 the service. 
 
 In Willcox v. The Consolidated Gas Company 2 the Court 
 considered the question again, saying: 
 
 There is no particular rate of compensation which must in all 
 cases and in all parts of the country be regarded as sufficient for 
 capital invested in business enterprises. Such compensation must 
 depend greatly upon circumstances and locality. Among other 
 things, the amount of risk in the business is a most important fac- 
 tor as well as the locality where the business is conducted and the 
 rate expected and usually realized there upon investments of a 
 somewhat similar nature with regard to the risk attending them. 
 
 The Court held that six per cent was a reasonable return 
 on property employed in rendering gas service. 
 
 In Knoxville v. The Knoxville Water Company 3 the 
 Court declined to consider whether four per cent was a fair 
 return on water works property, because the evidence was 
 not clear that the return would be reduced to this point. 
 
 No definite rule as to the amount of the return or the 
 elements necessarily included in it has been laid down. 
 Each case necessarily has been decided on its own facts. 
 
 The early decisions held the utility to a low rate of re- 
 turn, but the valuations were not strictly made. The later 
 commission cases have been more painstaking in the valua- 
 tion and more liberal in the rate of return. The courts have 
 always been more lax in their valuation and less liberal in 
 the return allowed than the commissions. 
 
 III. Elements involved in the Return 
 
 There has been considerable confusion among writers 
 upon utility rates and valuation, as well as in the decisions, 
 
 1 192 U. S. 201, 26 Sup. Ct. 241, 48 L. ed. 406. 
 
 2 212 U.S. 19, 29 Sup. Ct. 192, 53 L. ed. 382. a 212 U.S. 1.
 
 THE RETURN ON THE INVESTMENT 223 
 
 as to what constitutes the rate of return. Mr. H. G. Barker 
 
 says: x 
 
 It is obvious that capital will flow into a field, if it secures (1) 
 ordinary local interest return, plus (2) compensation for business 
 risks, plus (3) some reward for the actual attention required from 
 the investor, and plus (4) the possibility of more or less profit 
 above these other factors which partake much of the nature of 
 mere wages of capital and capitalists. 
 
 This classification is somewhat more minute than practical. 
 The courts and commissions have seldom troubled them- 
 selves with such delicate distinctions. They have uniformly 
 held that two principal elements, interest and profits, are 
 involved in the return. 2 
 
 The sum of interest and profit, though not fixed by law, 
 is necessarily limited by economic rules so long as the un- 
 dertaking is dependent upon private capital. The return 
 must be equal that available in other industries where the 
 risk is the same, or maintenance will be neglected, ad- 
 ditions and betterments postponed, and eventually the 
 capital will be drawn from the utility field. It is true that 
 the conduct of the utility by private capital is a public un- 
 dertaking, and that society as a whole has a direct proprie- 
 tary interest in the profits, but it is equally true that such 
 interest is non-enforceable below the point of return offered 
 by equally safe investments. The only way in which society 
 can reduce the return below that point is by decreasing the 
 
 1 Public Utility Rates (1917), p. 96. 
 
 2 A Federal Court states generally the considerations involved in the 
 rate of return, thus: "In fixing the measure of return upon property 
 devoted to public use, regard should be had to the character of the busi- 
 ness, the locality and the risk, whether the return will be uniform and 
 secure; whether the patronage is steady or fluctuating and quickly re- 
 sponsive to financial and commercial changes, interest rates legal and 
 contractual and the rates customarily sought and required in like in- 
 vestments in the locality; if a railroad, the character of the traffic, whether 
 largely of a kind dependent upon uncertain conditions or so diversified 
 that causes affecting part will not greatly affect the whole." Missouri, 
 Kansas & Texas Railway Company v. Love, 177 Fed. 493, 502.
 
 224 FAIR VALUE 
 
 risk and with it both the interest and profit elements. If 
 the social interest in profits is to be fully collected, society 
 must take over the business and directly assume the 
 risks. 
 
 IV. The Interest Element in the Return 
 
 Rate valuation is but a step in the determination of the 
 cost of producing the service. The angle from which the 
 question is approached, however, is not the same in public- 
 utility and industrial cost problems. For this reason rate 
 valuation has been able to avoid the scholastic conflict 
 stirred up by the Harvard school of accountants as to the 
 expediency of including interest in cost figures. Interest 
 has been uniformly excluded from operating expenses and 
 treated as a part of the return by commissions and courts. 
 So far as regulation is concerned there is absolutely no dif- 
 ference between interest and profit, other than the nature 
 of the elements on which their allowance is premised. Pro- 
 vision for neither is mandatory in the absence of reasona- 
 bleness in expenditures, location, etc. Both must be pro- 
 vided for when operation has been above reproach. Money 
 cannot be secured for any undertaking unless a certain an- 
 nual percentage or pure interest is paid for its use, but this 
 is equally true of profit. 
 
 The interest element of the return was commonly fixed 
 by the courts, in the early cases, at the legal rate. 1 The 
 later cases have realized that the interest rate itself is af- 
 fected by the risk and many other elements, and the tend- 
 ency has been to consider the rate of return as a whole, 
 rather than to separate it into its unit parts. 
 
 1 Pennsylvania R.R. Co. v. Philadelphia Co., 220 Pa. St. 100, 68 Atl. 
 676, 15 L.R.A. (N.S.) 108; Louisville & Nashville R.R. Co. v. Brown, 
 123 Fed. 946; Columbus Railway & Light Co. v. Columbus, U.S. Circuit 
 Co. (So. Dist. Ohio) Eq., No. 1206; Central of Georgia Railway Co. v. 
 Railroad Commission of Alabama, 161 Fed. 925; People ex rel. Jamaica 
 Water Supply Co. v. Tax Comm., 196 N.Y. 39; etc.
 
 THE RETURN ON THE INVESTMENT 225 
 
 V- The Risk Element in the Return 
 
 The element of risk, as applied to present-day conditions, 
 has received unmerited attention in discussions of the rate 
 of return. The hazard element is dual. The "risk " for which 
 the rate of return provides compensation may be defined 
 as the inherent hazard of the public service which subjects 
 the investment therein to liability of loss. Beside this there 
 is another class of risks due to possible faults of manage- 
 ment. Risks of the first type must be considered when they 
 are present, and there are many elements of such risk in- 
 volved in every public-utility operation; but there is prob- 
 ably no other business which is quite so free from the or- 
 dinary industrial risks as the public-service undertaking. 
 
 The operation of the risk element is the same in the util- 
 ity field as elsewhere. Any element which decreases the prob- 
 ability of a steady or adequate return must be considered 
 in fixing the rate. Thus the character and needs of the con- 
 sumers, the location, the possibility of developing the terri- 
 tory at reasonable cost, the presence of substitute service, 
 the possibilities of development in the industry, actual 
 competition, etc., mistakes in construction and operation, 
 accidents, poor judgment, unexpected failure of demand, 
 inability to establish financial connections, and similar op- 
 portunities for loss are commonly encountered. 
 
 The greatest industrial risks occur in the competitive 
 field and result from the incessant struggle between pro- 
 ducers, price wars, over-production, the unsettled state 
 of the industry, market fluctuations, and changing methods 
 of production. These risks have for the most part been elim- 
 inated in the public-utility field. 
 
 The recognition of regulated monopoly, and the exten- 
 sive elimination of competition, have done much to make 
 public-utility investments secure and the return on them 
 uniform and certain. Many circumstances have combined 
 to create a stable, uniform, constantly increasing demand 
 for service.
 
 226 FAIR VALUE 
 
 The second type of "risks" are those which arise from 
 poor judgment, improper organization, poor location, bad 
 management, unsound financial policies, etc., rather than 
 from any danger inherent in the undertaking itself. Such 
 risks truly affect both the interest and profit elements of 
 the return, but they are properly treated in a regulatory 
 programme as a distinct factor in return, namely, "the 
 reward for efficient management." 
 
 The industrial risk is susceptible to approach from three 
 angles, the risk when the original investment was made, 
 the risk as reflected by current market reports on the com- 
 pany's bonds and the present estimated risk in case of re- 
 production. 
 
 The first approach has been uniformly rejected. Expe- 
 rience has taught that the past return has in most cases am- 
 ply compensated the utility for the original hazard. 1 Where 
 this has not been true most commissions have preferred 
 to include the early risk in the allowance for going value. 
 The nature of the hazard is not such as to warrant perpet- 
 
 1 It does not seem out of place to suggest also that many of the early 
 utility risks were assumed for expected return other than that to be de- 
 rived from the legitimate operation of the business. A number of Amer- 
 ica's great fortunes are monuments to the early risk in the public-service 
 field. Few of the gigantic risks so often referred to in the case of the rail- 
 ways were assumed without provision for tenfold return from the de- 
 velopment of land held by the profiteers, without government aid which 
 in itself was ample guarantee against the risk assumed, or with a view to 
 multiplying return by financial manipulation, reorganization, etc. The 
 fact that the payment for the risk may have been misapplied or that 
 present holders who purchased during the boom took their stock after 
 the "melon" was cut can scarcely be considered justification for collect- 
 ing for the risk a second time. 
 
 This same line of thought leads to the conclusion that many of the 
 elements of risk have been self-imposed. Thus the report of W.A. Gunter, 
 special master in the South & North Alabama Case, 197 Fed. 595, at 
 page 84, says: "Railroad business is confessedly more than an ordinarily 
 risky one. The roads seldom have escaped receivership and bankruptcy 
 proceedings." Chapters of Erie and memories of the Alton Reorgani- 
 zation aid much in understanding these failures and bankruptcies, and 
 are potent arguments against over-estimation of the risk element in 
 return.
 
 THE RETURN ON THE INVESTMENT 227 
 
 uation of a return based upon it long after the risk has 
 ceased to exist. Early risks and early losses must be amor- 
 tized, not permanently capitalized against the public. And, 
 as already explained, they can be considered only on a con- 
 clusive showing that they actually existed, that the taking 
 of the risk was reasonable, and that no reparation has been 
 made. 
 
 The second figure is that which would make the market 
 value of the securities substantially equal to the real in- 
 vestment. This theory has not been definitely stated by 
 the commissions, but seems to have been acted upon in 
 several cases. 
 
 The third angle, from which the question of return is ap- 
 proached, is that along which the general economic forces 
 shaping industrial return in the competitive field com- 
 monly move. It has been universally accepted in the case 
 of utilities, however, not because it fits the regulatory the- 
 ory best, but because the institution of private operation 
 forces its adoption. So long as capital can secure a higher 
 return at equal risk elsewhere it will not be invested in the 
 utility field. 1 
 
 VI. The Rate of Return 
 
 Public-utility risks have been reduced to a minimum, and 
 the reduction has eliminated the necessity for speculative 
 profits. It is not necessary to offer large returns or to per- 
 mit speculation or manipulation of securities to attract 
 
 1 This phase of the problem is clearly stated by the New York First 
 District Commission in Queens Borough Gas & Electric Company, 2 
 N.Y. P.S.C. (1st Dist.) 544, thus: "Various standards have been sug- 
 gested for determining the fair rate of return. The one which in our 
 opinion is properly applicable to this case is that the rate should be such 
 that investors would be induced to provide the funds with which to con- 
 struct and extend a gas and an electric plant within the area in question. 
 If the State were to fix a rate below this standard, capital could not be 
 secured. If investment were made before the State acted, the original 
 capital might be forced to remain, but additional capital could not be 
 secured unless necessary to protect the first outlay."
 
 228 FAIR VALUE 
 
 capital to-day. Government bonds bearing three per cent 
 interest sell at a premium in normal times, and two per 
 cent federal securities are quoted around ninety-nine. 1 City 
 and county bonds ordinarily are readily sold at five per 
 cent and command a premium at six. State bonds, and the 
 securities of the more substantial railroad and industrial 
 corporations, bearing interest at four and a half per cent, 
 sell at par. And the seven per cent preferred stock of such 
 companies usually nets six per cent on the market price. 
 Savings banks pay three and four per cent. And the legal 
 rate of interest is usually from five to seven per cent. The 
 interest rate is universally low where the risk to the invest- 
 ment is small and the return certain. 
 
 It is clear from this survey that the interest rate is a 
 variable item. Where capital moves freely the rate varies 
 from day to day with the money market quotations. The 
 interest rate, if separately fixed, is purely a matter of busi- 
 ness judgment. Usually no attempt is made to determine 
 it apart from the total return. 
 
 The allowance in addition to the interest rate necessary 
 to provide a fair return on the investment need not be large. 
 The average public utility is financed to a great extent by 
 bond issues. The bondholders receive a stipulated per cent 
 on their funds which is materially below the return re- 
 ceived by the utility. A rate of return, on the total value 
 of the property, but slightly greater than the interest rate 
 on the bonds, will afford a relatively high dividend because 
 the profit earned on the borrowed capital will be distributed 
 among the stockholders. Thus, where one half of the cap- 
 ital has been secured by bonds bearing five per cent, a 
 seven per cent return on the valuation will allow a nine 
 per cent dividend. If the bond interest was six per cent, an 
 eight per cent return would afford a ten per cent dividend, 
 etc. 
 
 1 The interest rate, of course, is far from normal during the present 
 crisis. The figures given are based upon estimated normal conditions.
 
 THE RETURN ON THE INVESTMENT 229 
 
 No definite figure of return can be stated. Any general 
 deduction from the decisions would be most misleading be- 
 cause the elements considered in the return vary with the 
 method of valuation used, with the financial policy which 
 the utility has pursued, and with the managerial ability 
 which it has displayed. 
 
 VII. Duplication in Valuation and Return 
 
 The amount to be allowed in the return must necessarily 
 be influenced by many elements, in addition to the finan- 
 cial policy of the utility, which are peculiar to the particu- 
 lar case. The elements to be considered must be determined 
 to a large extent by the valuation methods employed. Many 
 questions considered in connection with the determination 
 of the fair value of the property are encountered again in 
 the consideration of the return. Development costs, going 
 value, and franchise value are the principal items considered 
 in connection with the "risk-of- the- undertaking" element 
 in the return. If such values have been fully included in the 
 valuation they cannot be allowed a second time as a factor 
 in the rate of return, irrespective of the terms under which 
 they are suggested. If early losses have been considered in 
 an allowance for going value, the investor has been prac- 
 tically compensated for the risk he assumed, and the re- 
 turn need cover little more than pure interest. In short, 
 if the risk element has been provided for under any allow- 
 ance in the valuation, it is eliminated from consideration in 
 the return. 
 
 VIII. Reward for Efficient Management 
 
 One of the principal elements which makes the return 
 vary to meet the facts of the particular cases is the neces- 
 sity for rewarding efficient management. The rate of return 
 is a sort of regulatory balance wheel. Valuation is neces- 
 sarily inaccurate and inflexible. The fixing of the return 
 affords the commission an opportunity to consider the equi-
 
 230 FAIR VALUE 
 
 ties of the case and make regulation an aid, not a burden 
 to operation. 
 
 When a utility has rendered adequate and efficient serv- 
 ice in an enterprising, up-to-date manner, has met the 
 standards fixed by the regulatory body, and otherwise sat- 
 isfactorily discharged its duties toward the public, the rate 
 of return must recognize the efficiency and reward it to the 
 same extent that the same degree of managerial ability 
 exerted in other lines of industry would be rewarded. A 
 well-managed, progressive utility, which has taken every 
 step to render adequate service at the lowest cost, to de- 
 velop its territory and maintain amicable relations with 
 its consumers, must be allowed a greater return than a util- 
 ity which has been inefficiently managed. x 
 
 Careless and inefficient management has been actually 
 penalized. 2 Thus, in Re Monmouth Public Service Com- 
 pany the Illinois Public Utilities Commission said: 
 
 This Commission has heretofore taken the position that finan- 
 cial rewards in public-utility enterprises should be commensurate 
 with the ability displayed in their management, and rates of re- 
 turn approximating seven per cent have been frequently permitted 
 in cases wherein the stewardship appeared competent. In the case 
 at bar, the record discloses that normal ability has not been dis- 
 played in the management of petitioner's gas property and the 
 standards of service have not been complied with, and to assume 
 mediocre stewardship is entitled to the same rewards as capable 
 conduct of affairs is to enunciate a doctrine at variance with the 
 •jum of human experience and with principles well recognized in 
 the business world. 
 
 The reward for managerial ability and economical opera- 
 tion is but the injection into the regulatory programme of 
 a substitute for the incentives offered individual initiative 
 in the absence of rate regulation. 
 
 1 Warren Light & Power Co., 5 111. P.U.R. 72; Union Gas & Elec. Co., 
 5 111. P.U.R. 205, etc. 
 
 2 Little York Elec. Co., 5 111. P.U.R. 80, P.U.R. 1918-B-120; Mon- 
 mouth Public Serv. Co., 5 111. P.U.R. 229; etc.
 
 THE RETURN ON THE INVESTMENT 231 
 
 EX. Allowance for Surplus 
 
 Following the report of the Railroad Securities Com- 
 mission to the President in 1911, the utility companies 
 throughout the country, particularly the railways, sought 
 to enforce the incorporation in the return of an allowance 
 to create a "reserve" or surplus to provide for "improve- 
 ments which add nothing to the earning capacity of the 
 property and ought not to be the basis of increased cap- 
 ital liability." » 
 
 Such an allowance cannot be justified under any con- 
 ceivable theory of regulation. It would force the public to 
 donate exchange value to the railway, without any return 
 for the compulsory gift, on the theory that the asset could 
 not be included in the rate base. If the expenditure is rea- 
 sonably necessary to permit or promote efficient service, 
 there is no rule of valuation which would exclude it in rate 
 cases. If the expenditure is such that it does not add to the 
 service, and is not beneficial to the consumers, there can be 
 no justification for taxing it against the consumer, espe- 
 cially where the service rendered is public. If such an ex- 
 penditure can be truly justified on any ground, it will be 
 provided with ample return by the allowance for efficient 
 management. 
 
 X. Summary 
 
 The consideration of the rate of return closes the study 
 of fair value. It fixes definitely the place of valuation in reg- 
 ulation. It clarifies many of the problems of valuation. The 
 determination of the rate of return supplements the valua- 
 tion and both are subsidiary to the final issue, the reason- 
 ableness of rates. Many of the problems of valuation have 
 been raised by the lack of understanding of the elements of 
 return. It is doubtful, for example, whether the dispute 
 over going value would have ever assumed the proportions 
 it has if the return to be allowed upon the fair value of the 
 1 Report of Railroad Securities Comm. (1911), p. 30.
 
 232 FAIR VALUE 
 
 property had been understood by commissions and utilities 
 alike. The same is true of franchise value. 
 
 The rate of return acts as a balance wheel to make regu- 
 lation run smoothly by adjusting the more or less arbitrary 
 rules to the individual cases, and by counteracting so far 
 as possible the dangers from the inevitable inaccuracies in 
 the estimates of value. It assures the investor interest on 
 his capital proportionate to the risk he assumes, and in 
 addition thereto a fair profit which is proportionate, not 
 only to the risk, but to the quality of the service and the 
 nature of the management. 
 
 Regulation seeks to secure the advantages of both com- 
 petition and monopoly. Valuation keeps the rate near the 
 reasonable cost of production and allows the economies of 
 monopolistic operation. The rate of return provides the in- 
 centive for individual initiative which regulation would de- 
 stroy if rates were based on absolute cost.
 
 CHAPTER X 
 CONCLUSION 
 
 The diversity of subject-matter, the necessity of consider- 
 ing the divers theories of many independent jurisdictions, 
 and the confusion in valuation law and practice render any 
 consideration of "fair value" unavoidably incoherent. It 
 seems desirable, therefore, in concluding a study of this 
 subject, to direct attention to the fundamental principles 
 of valuation, its aims, and the general trend of commission 
 action, with a view to leaving the reader with a concise idea 
 of the nature of "fair value." 
 
 Confusion will be avoided if the following prehminary 
 points are kept in mind: 
 
 (1) That the public utility is essentially different from other 
 
 industry; 
 
 (2) That private property devoted to the public use is not the 
 
 same as other private property, and does not enjoy 
 the same legal protection; 
 
 (3) That the service rendered is governmental in its nature, 
 
 and; 
 
 (4) That the purpose of regulation is curtailment of "private 
 
 rights" and the encumbrance of "private property." 
 
 "Fair value" is concerned chiefly with rate value, for 
 that value exercises a direct effect on all value for regula- 
 tory purposes. 
 
 Modern rate-making is a type of cost-finding, for rates 
 are based directly on the cost of the service. That cost is 
 made up of three items, material, labor, and burden. Rate- 
 making considers the first two elements in the allowance 
 for operating expenses. 1 Valuation deals with the burden 
 
 1 Rent may be an operating expense, but where the utility owns the 
 building and collects a return on the investment in it, it cannot collect a 
 second return as rent. Interest and bond discount are included in the 
 return, not in the operating expense.
 
 234 FAIR VALUE 
 
 or "expense" element. An appraisal or valuation is neces- 
 sary in cost-finding for two reasons. It shows burden, and 
 it is the basis on which return is figured. It may clarify mat- 
 ters to state the rate elements in equational form, thus : 
 
 (material + labor + maintenance + depre- 
 ciation + taxes + insurance) = operating expenses 
 
 (working capital + depreciated value of 
 
 physical and intangible property) =fair value 
 
 (interest +profit) = rate of return 
 
 fair value 
 
 operating expenses + ; = reasonable rate. 
 
 rate of return 
 
 The appraisals in regulatory and industrial cost-finding, 
 while they serve the same purpose, are drawn on different 
 lines. Industrial and public-utility valuation are inherently 
 different. The appraisal of the industrial plant, under com- 
 petitive conditions, involves no question of public interest 
 in profits, in management, or in service. When monopoly 
 exists, the public interest is not the same as that affecting 
 the public-service company. Industrial valuation usually 
 seeks to determine market value. Public-utility valuation, 
 though it may consider market value, can never be based 
 upon it alone, for rate value is not based on market value 
 and all regulatory value is influenced by the rate base. 
 
 The two valuations differ even when cost of production 
 is the ultimate question. In one case a speculative under- 
 taking is considered, in the other speculation is excluded. 
 The treatment of appreciation, depreciation, experiment, 
 provision for the future, property not used or useful, ap- 
 portionment of expenses, and many other items is neces- 
 sarily different in the two cases. The private property of 
 the public utility is burdened with a serious encumbrance 
 which materially decreases its value. No similar encum- 
 brance exists in the case of the industrial plant. 
 
 The cost of production sought in the two cases is itself 
 dissimilar. The industrial plant figures show actual cost. 
 The regulatory figures show reasonable cost.
 
 CONCLUSION 235 
 
 The general economic principles applicable in the un- 
 regulated industrial field do not necessarily have applica- 
 tion in either the monopolistic industrial field, under present 
 regulatory conditions, or in the public-utility field. Values 
 and prices in the one case are economic; in the other, legal. 
 The governmental character of the service and the recogni- 
 tion of monopoly set in operation political and legal forces 
 which render the situation wholly dissimilar to that in 
 the general field of business. The laissez-faire rules of the 
 general field do not apply to the anti-monopoly aims of 
 regulation in the monopolistic industrial sphere, nor to the 
 regulated monopoly conditions of the public-utility field. 
 Economic rules, founded on competition as the principal 
 regulatory force, have failed to direct the political and 
 legal forces which sweep the utility sphere. Those forces 
 must, therefore, shape the economic rules. 
 
 The first of the laissez-faire economic concepts which is 
 swept away by political and legal interpretation is the indi- 
 vidualistic idea of private property. In its place is set up 
 the social concept which recognizes an extensive public in- 
 terest in property. The stage has not been reached where 
 this interest is fully developed. The delegation of the gov- 
 ernmental function to private individuals, to transfer the 
 risk of the undertaking to private capital carries with it as 
 effective a check upon the social theory of property and 
 upon regulation as the individualistic economic and legal 
 theories themselves. So long as the business is dependent 
 upon private capital, the individualistic interests must be 
 extensively recognized to attract capital. 
 
 The second of the economic theories to fall by the way- 
 side is the value concept. "Value" in regulation does not 
 mean "economic" or "exchange" value because regulatory 
 value is based on rate value, and to measure rate value by 
 capitalized earnings, as exchange value is measured, in- 
 volves the vicious circle. The fair value of the public-utility 
 property for rate-making purposes is the present unim-
 
 236 FAIR VALUE 
 
 paired reasonable investment in property used and useful 
 in rendering the public service. 
 
 The next idol overthrown is the competition panacea. The 
 superficial assumption that the monopolistic nature of the 
 public utility is the basis of the distinction between public 
 and private service, and the equally superficial conclusion 
 that regulation is but a substitute for competition, are, per- 
 haps, responsible for more confusion in valuation than all 
 other theories combined. Such an approach to regulation 
 problems predestines the study to failure, for it can only 
 mean the application of laissez-faire, individualistic rules 
 to a sphere created for the express purpose of avoiding the 
 operation of those rules. Competition is based upon private 
 interest. Regulation is based upon public interest. 
 
 The development of the valuation theory is but the slow 
 swing of the conservative arm of the law to meet the changed 
 ideas of that body which moulds the law. The State Public 
 Utilities Commissions, in direct contact with the situation, 
 bound by no volume of precedent, bowed beneath the 
 weight of no judicial conservatism, and held in check by 
 no formal procedure, have far outdistanced the courts. A 
 consideration of the comparatively few recent cases in 
 courts of last resort indicates that the path blazed by the 
 commissions will be followed by the courts when possible.
 
 SELECTED BIBLIOGRAPHY
 
 SELECTED BIBLIOGRAPHY 
 
 General Works and Pamphlets 
 
 Allison — Should Public Service Properties Be Depreciated? 
 
 Bailly — The Legal Basis of Rate Regulation. 
 
 Barker — Public Utility Rates. 
 
 Beale & Wyman — Railroad Rate Regulation. 2d Ed. 
 
 Briefs filed with the Interstate Commerce Commission, Valuation 
 
 Division. 
 Collier — Public Utilities. 
 
 Collins — The Fourteenth Amendment and the States. 
 Cotton — An Argument Against Official Valuation of Railroad 
 
 Properties. 
 Erickson — Valuation of Public Utilities. 
 Floy — Valuation of Public Utility Properties. 
 Foster — Engineering Valuation of Public Utilities. 
 Hale — Valuation and Rate-Making. 
 Hayes — Public Utilities, Their Cost New and Depreciation. 
 
 — Public Utilities, Their Fair Present Value and Return. 
 McFall — Railway Monopoly and Rate Regulation. 
 McGehee — Due Process of Law. 
 Reeder — Validity of Rate Regulations. 
 Smalley — Railroad Rate Control. 
 Taylor — Due Process of Law. 
 Vanderblue — Railroad Valuation. 
 Whitten — Fair Value for Rate Purposes. 
 
 — Valuation of Public Service Corporations. 
 Wilcox — Principles as to Franchise Values. 
 Wyman — Public Service Corporations. 
 
 — Railroad Valuation and Rates. 
 Young — Depreciation and Rate Control. 
 
 Articles in Periodicals 
 
 Adams — Valuation of Public Service Utilities. 11 Am. Econ. 
 Ass'n Quarterly, 184. 
 
 Allison — Ethical and Economic Elements in Public Service 
 Valuation. 27 Q J. Econ. 27. 
 
 Baker — Valuation of Terminal Lands. 8 Journal of Account- 
 ancy, 239.
 
 240 SELECTED BIBLIOGRAPHY 
 
 Bauer — Depreciation and Rate Control. 29 Q.J. Econ. 362. 
 Bonbright — Depreciation and Rate Control. 30 Q.J. Econ. 546. 
 Brinckley — Why Appraisal is not Valuation. 72 Eng. Rec. 515. 
 Butler — Valuation of Railway Property for Purposes of Rate 
 
 Regulation. 23 J. Pol. Econ. 17. 
 Davis — Depreciation and Rate Control. 29 Q.J. Econ. 362. 
 Delano — Application of a Depreciation Charge. 16 J. Pol. 
 
 Econ. 585. 
 Edgerton — Value of the Service as a Factor in Rate-Making. 
 
 32 Harvard L. Rev. 516. 
 Gray — How Does Industrial Valuation Differ from Public 
 
 Utility Valuation. Utilities Magazine, January, 1917, p. 26. 
 Gray — The Vagaries of Valuation. 4 Am. Econ. Rev. 18. 
 Hale — The Supreme Court's Ambiguous Use of "Value" in 
 
 Rate Cases. 18 Col. L. Rev. 208. 
 Hansel — State Valuation of Railroads. 185 N. Am. Rev. 485. 
 Hayes — Original Cost v. Replacement Cost. 25 Q.J. Econ. 616. 
 Heilman — Principles of Public Utility Valuation. 28 Q.J. Econ. 
 
 269. 
 Henshaw — State Railway and Public Service Commissioners 
 
 on Railway Valuation. Utilities Magazine, March, 1916, p. 4. 
 Riggs — Problems of Railroad Valuation. 13 Columbia L. Rev. 
 
 582. 
 Ripley — Physical Valuation of Railroads. 29 Q.J. Econ. 569. 
 Robinson — Legal, Economic and Accounting Principles In- 
 volved in the Judicial Determination of Railway Passenger 
 
 Rates. 16 Yale Rev. 355. 
 Sakolski — Valuation of Railroad Right of Way. 6 Am. Econ. 
 
 Rev. 288. 
 Swayze — Regulation of Railway Rates Under the Fourteenth 
 
 Amendment. 26 Q.J. Econ. 389. 
 Thelen — Public Utility Rates, a Just and Scientific Basis. 
 
 2 Cal. L. Rev. 1.
 
 TABLE OF CASES
 
 TABLE OF CASES CITED 
 
 Advance on coal to lake ports, In Re, 22 I.C.C. 604 84 
 
 Aldnut v. Inglis, 12 East. 527 11 
 
 Alleghany Valley St. R.R. Co. v. Greco, (Pa.) P.U.R. 1917-A 723 . . 14 
 
 American U.T. Co. v. Western U.T. Co., 67 Ala. 26 20 
 
 Ames v. Union P. Ry. Co., 64 Fed. 165 58, 88, 110 
 
 Ann Arbor R. Co. v. Fellows, 236 Fed. 387 177 
 
 Apple v. Brazil, (Ind.) P.U.R. 1915-C 561 134, 154 
 
 Appleton v. Appleton Water Works Co., 5 W.R.C.R. 215. 110, 116, 191 
 Appleton Water Works Co., In Re, 6 W.R.C.R. 97, Affd. 154 Wis. 
 
 121 . 159 
 
 Ardmore Water Case! I.P.U.c! No. 4670 . . . . . . . . '. ! '. '. '. '. .......... 83 
 
 Ashland v. Ashland Water Co., 4 W.R.C.R. 273 134 
 
 Atlantic Coast Line v. N.C. Comm., 206 U.S. 1, 51 L. ed. 933 33 
 
 Banker v. L.D. R.R. Co., 89 Hun., (N.Y.) 202 16 
 
 Bay State Rate Case, In Re, (Mass.) P.U.R. 1916-F 221.136, 144, 167 
 
 Bee Bldg. Co. v. Savage, 91 N.W. 716, 65 Neb. 714 63, 79 
 
 Beekman v. Saratoga, etc. R.R., 3 Paige 45 16 
 
 Belcher, etc. Co. v. St. Louis G.E., 101 Mo. 192, 13 S.W. 822, 8 L.R.A. 
 
 801 21 
 
 Beloit v. Beloit Water, Gas & Elec. Co., 7 W.R.C.R. 187 134 
 
 Berlin Elec. Light Co., In Re, 3 N.H.P.S.C. 174. 95, 110, 115, 146, 173 
 Birmingham Mineral R.R. Co. v. Parsons, 100 Ala. 662, 13 So. 602. 20 
 
 Bloodgood v. Mohawk & H. R.R., 18 Wendell. 1 16 
 
 Blue Hill St. R. Co., (Mass.) P.U.R. 1915-E 370 174, 204 
 
 Bluefield v. Bluefield Waterworks & Imp. Co., (W. Va.) P.U.R. 
 
 1917-E 22 117 
 
 Bd. of Trade v. Mountain Home Tel. Co., (N.Y. 2d Dist.) P.U.R. 
 
 1916-C 688 133 
 
 Bogart v. Wisconsin Tel. Co., (Wis.) P.U.R. 1916-C 1020 84, 110 
 
 Bonbright v. Corporation Comm. of Arizona, 210 Fed. 44 153 
 
 Boston Beer Co. v. Massachusetts, 97 U.S. 25 20 
 
 Bound Creek Water Co., In Re 84 
 
 Boyd v. Alabama, 94 U.S. 645 19 
 
 Bradley v. Ohio River, etc. R.R. Co., 78 Fed. 387 16 
 
 Brass v. N. Dakota, 153 U.S. 391, 14 Sup. Ct. 857, 38 L. ed. 757. . . 21 
 Bridgeport Natural Gas & Oil Co., In Re, (W. Va.) P.U.R. 1916-C 
 
 253 84, 136 
 
 Bronx Gas & Elec. Co., In Re, (N.Y.) P.U.R. 1916-A 440 118, 136 
 
 Bronx Gas & Elec. Co., In Re, (N.Y. 1st Dist.) 'P.U.R. 1917-D 
 
 777 1 10 
 
 Brunswick & T.W. Dist. v. Maine Water Co., 99 Me. 371 84, 101 
 
 Brymer v. Butler Water Co., 179 Pa. 231, 36 Atl. 249 136 
 
 i.Budd v. New York, 143 U.S. 517, 12 Sup. Ct. 468 16, 21, 54 
 
 Buel v. Chicago, M. & St. P. Ry. Co., 1 W.R.C.R. 324 133 
 
 Buffalo Gas Co. v. Buffalo, 3 P.S.C. 2d Dist. (N.Y.) 553 110, 134
 
 244 TABLE OF CASES 
 
 Butchers' Union Slaughter House Co. v. Crescent City Live Stock 
 
 Landing Co., Ill U.S. 746, 16 Wall. 36 20 
 
 Butler v. Lewiston, A. & W. St. Ry., (Me.) P.U.R. 1916-D 25 
 
 32, 84, 110, 199 
 
 Camara De Comercie v. Manila Elec. R. & L. Co., (P.I.) P.U.R. 
 
 1915-D 977 84, 174, 181 
 
 Campbell v. Hood River Gas & Elec. Co., (Or.) P.U.R. 1915-D 855 
 
 101, 154, 166, 174, 206 
 
 Capital City Gaslight Co. v. City of Des Moines, 72 Fed. 829 105 
 
 Cayuga Power Corp. (N.Y.) P.U.R. 1917-E 915 14 
 
 - Cedar Rapids G.L. Co. v. City of Cedar Rapids, 223 U.S. 665, 32 
 
 Sup. Ct. 389 182 
 
 Central of Ga. Ry. v. R.R. Comm. of Ala., 161 Fed. 925 224 
 
 Central of Ga. Ry. v. R.R. Comm. of Ga., U.S. Dist. Ct. Middle Dist. 
 
 Ala. No. 261, Equity 133 
 
 Central Pacific R. Co., In Re, (Cal.) P.U.R. 1916-B 845 108, 166 
 
 Charleston v. Omro Elec. L. Co., (Wis.) P.U.R. 1915-B 1 136 
 
 Charles Town Water Co., In Re 84 
 
 Chesapeake & P. Tel. Co., (Md.) P.U.R. 1916-C 925 167, 199 
 
 Chicago & G.T.R.R. v. Wellman, 143 U.S. 412, 12 Sup. Ct. 400, 36 L. 
 
 ed. 176 20, 54 
 
 Chicago & Northwestern Ry. Co. v. Smith, 210 Fed. 632 150, 177 
 
 Chicago, B. & Q. R.R. v. Chicago, 166 U.S. 226, 17 Sup. Ct. 581 . . 56 
 
 Chicago, B. & Q. R.R. Co. v. Iowa, 94 U.S. 155, 24 L. ed. 94 9, 47 
 
 Chicago, etc. R.R. v. Dey, 35 Fed. 866 60 
 
 Chicago, Milwaukee & North Shore Elec. Ry. Co., In Re, P.U.R. 
 
 1918-A 388 144, 151, 174, 206 
 
 Chicago, Milwaukee & St. P. Ry. Co. v. Ackley, 94 U.S. 179, 24 L. ed. 
 
 94 9 
 
 Chicago, M. & St. P. Ry. Co. v. Minnesota, 134 U.S. 418, 10 Sup. Ct. 
 
 462 20, 52 
 
 Chicago, M. & St. P. Ry. Co. v. Tompkins, 176 U.S. 167, 44 L. ed. 
 
 418, 20 Sup. Ct. 336 20 
 
 Chicago North Shore Elec. Ry. Co., (111.) P.U.R. 1918-A 388 
 
 144, 174, 206 
 
 Citizens' Tel. Co., In Re, (Ind.) P.U.R. 1919-B 352 174 
 
 City Water Co., In Re, (Mo.) P.U.R. 1917-B 624 174 
 
 Cleveland, Cin., Chi. & St. L. Ry. Co. v. Backus 154 U.S. 439 178 
 
 Clyde v. Richmond & D.R. Co., 57 Fed. 436 84 
 
 Coke Products Ass'n of Connellsville v. B. & O. R. Co., 27 I.C.C. 
 
 125 84 
 
 Coles Co. T. & T. Co., In Re, I.P.U.C. Nos. 7280, 7313 14 
 
 Colorado F. & I. Co. v. Southern P. Ry., 6 I.C.C. 489 33 
 
 Colorado Springs Light, Heat & Power Co., In Re 84 
 
 Columbia v. Watts Engineering Co., (Mo.) P.U.R. 1915-B 921 
 
 168, 169, 170 
 Columbus Ry. & L. Co. v. Columbus, U.S. Cir. S.D. Ohio Eq. No. 
 
 1206 224 
 
 Commercial Club v. Citizens G. & L. Co., (Ind.) P.U.R. 1916-E 1 
 
 110, 134 
 Commercial Club v. Mo. P. Util. Comm., (Mo.) P.U.R. 1915-C 1017 . 88 
 Commercial Club v. Terre Haute Waterworks, (Ind.) P.U.R. 1916- 
 
 B 180 134
 
 TABLE OF CASES 245 
 
 Commission Cases, 116 U.S. 307, 6 Sup. Ct. 834 48, 51, 53, 62 
 
 Consolidated Gas Co. v. Wilcox, 157 Fed. 854 Ill 
 
 Corona v. Corona Home T. & T. Co., (Cal.) P.U.R. 1915-F 1014 
 
 173 193 
 
 Cotting v. Goddard, 183 U.S. 79, 22 Sup. Ct. 30 ' 22 
 
 Cotting v. Kansas City S. Yd. Co.. 82 Fed. 850 58, 90 
 
 Covington Turnpike R.R. v. Sanford, 164 U.S. 578, 17 Sup. Ct. 198 
 
 20, 55, 58, 60, 72 
 Cripple Creek Water Co., In Re, (Cal.) P.U.R. 1916-C 788. . 110, 117, 171 
 
 Croty v. Tomah Elec. & T. Co., (Wis.) P.U.R. 1917-A 439. 211 
 
 Crownover Telephone Co., In Re, (Neb.) P.U.R. 1915-E 571 88 
 
 Culver v. St. Joseph & C.I. Ry., (Mo.) P.U.R. 1917-B 542 16 
 
 Cumberland T. & T. Co. v. Louisville, 187 Fed. 637 203 
 
 Danville v. Danville Water Co., 178 III. 299, 53 N.E. 118, 60 Am. St. 
 
 Rep. 304 20 
 
 Darlington Elec. Light & Water Power Co., In Re, 5 W.R.C.R. 397 130 
 Delaware, etc. R.R. v. Central Stock Yd. Co., 45 N.J. Eq. 50, 6 L.R.A. 
 
 855 21 
 
 Denver v. Denver Union Water Co., 62 L. ed 189 
 
 Des Moines Gas Co. v. Des Moines, 199 Fed. 204 115 
 
 Des Moines Gas Co. v. Des Moines, 238 U.S. 113, 59 L. ed. 1244 
 
 158, 182, 189 
 
 Des Moines Water Co. v. Des Moines, 192 Fed. 193 203 
 
 Dow v. Beidelman, 125 U.S. 680, 8 Sup. Ct. 1028 51, 56, 58 
 
 Dunham, In Re, (Mo.) P.U.R. 1916-E 544 110, 116, 174 
 
 East Bakersfield Imp. Ass'n v. San Joaquin L. & P. Corp., (Cal.) 
 
 P.U.R. 1916-C 830 155 
 
 East Hartford v. Hartford Bridge Co., 10 How. 511 19 
 
 Edwards v. Glen Tel. Co., (N.Y. 2d Dist.) P.U.R. 1916-B 940. 116, 167 
 Ely, City of, v. Ely Light & Power Co., (Nev.) 24 Comm. Leaf. 578 154 
 Express Rates, Ind. R. Comm. No. 495 79 
 
 Fall River Gas Works v. Bd. of Gas & Elec. L. Comm. 214 Mass. 529, 
 
 102 N.E. 475 136 
 
 Freeport Water Co. v. Freeport, 186 111. 179, 57 N.E. 862 20 
 
 Ft. Supply T. & T. Co. v. Pioneer T. & T. Co., P.U.R. 1917-A 188 38 
 Fuhrmann v. Cataract Power & Conduit Co., 3 P.S.C. 2d Dist. N.Y. 
 
 656 79, 88, 146, 181 
 
 Galena Water Co. v. City of Galena, 74 Kan. 624, 87 Pac. 735 179 
 
 Geer v. Baltimore & Ohio R. Co 84 
 
 Georgia R. & Banking Co. v. Smith, 128 U.S. 174, 9 Sup. Ct. 47, 32 
 
 L. ed. 377 20, 52 
 
 German Alliance Ins. Co. v. Lewis, 233 U.S. 389, 34 Sup. Ct. 612, 58 
 
 L. ed. 1011, 42 L.R.A. (N.S.) 100 24 
 
 Gloucester Water Supply Co. v. Gloucester, 179 Mass. 365, 60 N.E. 
 
 977 179 
 
 Goezler v. Georgetown, 6 Wheat. 593 19 
 
 Grafton Co. Elec. Light & Power Co., In Re, 282A.T. & T. Co., 
 
 Comm. Leaflets 533 84, 115, 155 
 
 Grafton Co. Elec. Light & Power Co., In Re, (N.H. Sup. Ct.) 
 
 P.U.R. 1917-E 345 156
 
 246 TABLE OF CASES 
 
 Grafton Co. Elec. Light & Power Co., In Re, (N.H.) P.U.R. 1916- 
 
 E 879 155, 187 
 
 Greensburg v. Westmoreland Water Co., (Pa.) P.U.R. 1917-D 478 
 
 118, 153, 174 
 
 Haverhill Gas Light Co., In Re, Mass. Bd. G. & E.L.C. 9 Ann. 
 
 R. 90 136 
 
 Herman v. Newton Gas Co., (N.Y. 1st Dist.) P.U.R. 1916-D 825 
 
 164, 167, 173 
 
 Hill v. Antigo W. Co., 3 W.R.C.R. 623 79 
 
 Holyoke, City of, v. Holyoke Water Power Co., Ann. Rep. Mass. G. 
 
 & E. Light Coram. 1903, p. 77-82 179 
 
 Indianapolis Water Co., In Re., P.U.R. 1917-E 556 118, 146 
 
 Indianapolis Water Co., In Re., P.U.R. 1919-A 448 112, 115 
 
 Interstate Commerce Comm. v. Chicago Gt. Western R. Co., 14 Fed. 
 1003 84 
 
 Janesville Water Co., In Re, (Wis.) P.U.R. 1915-A 178 199 
 
 Joplin & Pittsburg Ry. Co., In Re, (Mo.) P.U.R. 1919-B 366 174 
 
 Kansas City Elec. L. Co., In Re, (Mo.) P.U.R. 1917-C 728 118 
 
 Kennebec Water Dist. v. City of Waterville, 97 Me. 185, 54 Atl. 6 
 
 101, 179 
 
 Kings County L. Co. v. Willcox, 156 App. Div. N.Y. 603 63 
 
 Knott v. Chicago, B. & Q. R., 230 U.S. 474, 33 Sup. Ct. 975 74 
 
 Knoxville v. Knoxville Water Co., 212 U.S. 1, 29 Sup. Ct. 149 
 
 90, 121, 203, 222 
 
 LaCrosse Gas & E. Co., In Re, 8 W.R.C.R. 138 130 
 
 Lake Forest v. Lake Forest Water Co., I.P.U.C. No. 2343 and 2275, 
 
 P.U.R. 1915-D 1008 38, 106 
 
 Lake Shore & M.S. Ry. Co., I.P.U.C. No. 2495 38 
 
 Lake Shore & M.S. Ry. v. Ohio, 173 U.S. 285, 19 Sup. Ct. 465, 43 L. 
 
 ed. 702 20 
 
 Lamar v. Intermountain R.L. & P. Co., (Col.) P.U.R. 1918-B 86 . 174, 213 
 
 Landon v. Lawrence, (Kan.) P.U.R. 1916-B 331 136 
 
 Laurel Fork & S.H. R. Co. v. West Virginia T. Co., 25 W. Va. 324 . 19 
 
 Lima v. Lima T. & T. Co., (Ohio) P.U.R. 1916-E 670 166, 174, 206 
 
 Lincoln v. Lincoln Water & Light Co., I.P.U.C. No. 2496, P.U.R. 
 
 1917-B 1. 95, 99, 103, 108, 110, 112, 115, 117, 162, 168, 173, 174, 199 
 
 Lincoln Gas & Elec. Light Co. v. Lincoln, 223 U.S. 349 123 
 
 Little York Elec. Co., 5 111. P.U.R. 80 230 
 
 Los Angeles, In Re, (Cal.) P.U.R. 1916-F 593 136, 166 
 
 Louisville & N. R.R. v. Brown, 123 Fed. 946 224 
 
 Louisville & N. R.R. v. Kentucky, 183 U.S. 503, 22 Sup. Ct. 95 . . . . 33 
 Louisville & N. R.R. v. R.R. Comm., 196 Fed. 800 Ill, 146 
 
 Manitowoc W.W. Co., In Re, 7 W.R.C.R. 71 63, 79, 88, 131, 159 
 
 Mantua Twp. v. New Jersey Gas Co., (N.J.) P.U.R. 1916-C 163.. . 164 
 
 Marbury v. Madison, 1 Cranch 137, 2 L. ed. 60 50 
 
 Marin Municipal Water Dist., In Re, (Cal.) P.U.R. 1915-C 433 
 
 134 154 
 Marquis v. Polk County Tel. Co., (Neb.) P.U.R. 1915-C 140 ' 108
 
 TABLE OF CASES 247 
 
 Mayhew v. Kings County L. Co., 2 P.S.C. (1st Dist.) N.Y. 659 
 
 63, 88, 158, 169, 194 
 
 McCullough v. Brown, 41 S.C. 247 21 
 
 Meek v. Consumers' Elec. L. & P. Co., (Mo.) P.U.R. 1915-A 956. . 169 
 
 Memphis Cotton Oil Co. v. I.C.R. Co., 17 I.C.C. 313 84 
 
 Mercantile Trust Co. v. Texas & P. Ry. Co., 51 Fed. 529 177 
 
 Metropolitan St. Ry. Co., In Re Reorganization, 3 P.S.C. (1st Dist.) 
 
 N.Y. 113 170, 173, 177 
 
 Michigan C.R.R. v. Michigan R.R. Comm., 236 U.S. 615, 59 L. ed. 
 
 750 20 
 
 Michigan State Tel. Co., In Re, (Mich.) P.U.R. 1918-C 81 179 
 
 Middlesex & Boston Rate Case, In Re 116 
 
 Minnesota & St. L. R.R. v. Minnesota, 186 U.S. 257,46 L. ed. 1151, 
 
 22 Sup. Ct. 901 31, 73 
 
 Minnesota Rate Case (1st) 134 U.S. 418, 10 Sup. Ct. 462 52, 54 
 
 Minnesota Rate Case, 230 U.S. 352, 33 Sup. Ct. 729 
 
 73, 84, 123, 124, 145, 147, 150, 152, 181 
 
 Minnesota Rate Case, 184 Fed. 765 169 
 
 Mississippi River & B.T.R. Co., In Re, (Mo.) P.U.R. 1918-C 321 . . 174 
 
 Missouri, Kans. & Texas Ry. Co. v. Love, 177 Fed. 493 223 
 
 Missouri Rate Case, 230 U.S. 471 74 
 
 Missouri Southern R. Co., In Re, (Mo.) P.U.R. 1916-C 607 
 
 166, 177, 206 
 
 Monahan v. Pacific G. & E. Co., (Cal.) P.U.R. 1916-B 609 105 
 
 Monmouth Pub. Serv. Co., 5 111. P.U.R. 229 230 
 
 Monongahela Navigation Co. v. United States, 148 U.S. 312, 13 Sup. 
 
 Ct. 622, 37 L. ed. 463 190 
 
 Monongahela Water Co., In Re, 223 Pa. St. 323, 72 Atl. 625 179 
 
 Monroe Independent Tel. Co., (Neb.) P.U.R. 1917-E 471 117 
 
 Montpelier & Barre L. & P. Co., In Re, P.U.R. 1916-B 973 156 
 
 Mountain States Tel. & Telg. Co., In Re, (Col.) P.U.R. 1917-B 198 
 
 166, 167 
 Municipal League v. Pacific G. & E. Co., 21 A. T. & T. Co. Comm. 
 
 Leaf. 699 . , 146 
 
 Munn v. Illinois," 04 U.S. iis, 24 L. ed. 72 '.'.'.'.'.'.'.WW .WW". .9, 16, 45 
 Murry v. Pub. Utilities Comm., (Idaho Sup. Ct.) 150 Pacific 47, 
 
 P.U.R. 1915-F 436 105, 204 
 
 Nash v. Page, 80 Ky. 539, 44 Am. Rep. 490 21 
 
 Nat'l Hay Ass'n v. Michigan C.R.R. Co., 19 I.C.C. 34 84 
 
 Nat'l Water Works Co. v. Kansas City, 62 Fed. 853, 10 CCA. 653, 
 
 27 L.R.A. 827, 27 U.S. App. 165 178 
 
 New Orleans G. Co. v. Drainage Comm., 197 U.S. 453, 25 Sup. Ct. 471 20 
 New York & N.E. R.R. v. Bristol, 151 U.S. 556, 14 Sup. Ct. 437, 38 
 
 L. ed. 269 20 
 
 New York, Ontario & Western Ry. Co. v. Shaw, 143 N.Y. App. Div. 
 
 811, 128 N.Y. Sup. 177 150 
 
 Norfolk & W. Ry. v. Conley, 236 U.S. 605, 49 L. ed. 745 32 
 
 North Coast Water Co., (Cal.) 26 Comm. Leaf, 1161 146 
 
 North E. Kans. R. Co., (Kans.) P.U.R. 1916-B 925 32 
 
 Northampton Co. Water Co., (Pa.) P.U.R. 1917-E 939 14 
 
 Northern Pacific Ry. Co. v. Duluth, 208 U.S. 583, 28 Sup. Ct. 341, 52 
 
 L. ed. 630 20 
 
 Northern Pacific Ry. v. N. Dakota, 236 U.S. 585, 59 L. ed. 735 . .81, 32, 73
 
 248 TABLE OF CASES 
 
 Ocean County Elec. Co., (N.J.) P.U.R. 1916-D 77 156 
 
 Ocean County Elec. Co., (N.J.) P.U.R. 1915-B 601 173 
 
 Oklahoma Gin Co. v. Oklahoma 84 
 
 Olcott v. Supervisors, 16 Wall 693, 21 L. ed. 382, 83 U.S. 678 10, 16 
 
 Omaha v. Omaha Water Co., 218 U.S. 180, 30 Sup. Ct. 615 
 
 63, 88, 179, 182 
 
 Omaha & L.R. & L. Co., (Neb.) P.U.R. 1915-B 416 175 
 
 Omaha W.W. Co. v. Omaha, 218 U.S. 180, 54 L. ed. 991, 30 Sup. Ct. 
 
 615 175 
 
 Oregon R. & Nav. Co. v. Clausen, 116 Pac. 7 63 
 
 Oshkosh Water Works Plant, In Re, 12 W.R.C. R.602 88, 134, 159 
 
 Oshkosh W.W. Co. v. R.R. Comm, 152 N.W. 859, P.U.R. 1915-D 
 
 336 63 
 
 Palo Alto Gas Case, 10 Rate Research 93 202 
 
 Pearsall v. G. Northern Ry., 161 U.S. 646, 16 Sup. Ct. 705 20 
 
 Peck v. Indianapolis Lighting & H. Co., (Ind.) P.U.R. 1916-B 445. 154 
 
 Peik v. Chicago & N.W. Ry. Co., 94 U.S. 164, 24 L. ed. 97 9, 46 
 
 Pennsylvania R.R. Co. v. Philadelphia, 220 Pa. St. 100, 68 Atl. 676, 15 
 
 L.R.A., (N.S.) 108 224 
 
 People v. N.Y.C. & H. R.R., 28 Hun., (N.Y.) 543 16 
 
 People ex rel. Jamaica Water S. Co. v. Tax Comm. 196 N.Y. 39. . . 224 
 People ex rel. Kings Co. L. Co. v. Pub. Serv. Comm. 210 N.Y. 479. 203 
 People ex rel. New York, Ontario & W. Ry. Co. v. Shaw, 143 App. 
 
 Div. N.Y. 811, 128 N.Y. Supp. 177 177 
 
 Petaluma & S.R. Co., (Cal.) P.U.R. 1915-C 742 168, 193, 194 
 
 Piercy v. Citizens G., E. & H. Co., (111.) I.P.U.C. No. 4896 107 
 
 Pillsbury v. Peoples Gas Light Co., 4 N.H. P.U.C. 391 189 
 
 Pine Lawn v. W. St. Louis Water & L. Co., P.U.R. 1917-B 679 
 
 118, 134, 167, 174 
 Planters' Compress Co. v. Cleveland, C.C. & St. L. Ry. Co., 11 
 
 I.C.C. 382 84 
 
 Planters' Compress Co. v. Mo., K. & T.R. Co., 11 I.C.C. 606 84 
 
 Portage v. Portage Water Co., (Pa.) P.U.R. 1917-D 17 118 
 
 Portland R. Light & P. Co., (Or.) P.U.R. 1916-D 976 
 
 106, 117, 154, 155, 166, 206 
 
 Portland R. Light & P. Co., (Or.) P.U.R. 1917-D 962 156 
 
 Potomac Elec. Power Co., (D.C.) P.U.R. 1917-D. 563 174, 211 
 
 Poy Sippi Tel. Co., (Wis.) P.U.R. 1917-B 469 14 
 
 Pub. Serv. Comm. v. Helena, 52 Mont. 527 20 
 
 Pub. Serv. Comm. v. Pacific P. & L. Co., (Cal.) P.U.R. 1915-A 88 154 
 Pub. Serv. Comm. v. Pacific P. & L. Co. (Wash.) P.U.R. 1916-B 86 156 
 Pub. Serv. Comm. v. Pacific T. &T. Co., (Wash.) P.U.R. 1916-D 947 110 
 Pub. Serv. Comm. ex rel. Seattle v. Lighting Co., (Wash.) P.U.R. 
 
 1915-B 135 174 
 
 Public Service G. Co. v. Pub. Ut. Comm., 87 Atl. 651, 85 N.J. 63, 
 
 79 88 
 
 Puget Sound T. L. & P. Co. v. Reynolds, 244 U.S. 574, 61 L. ed. 1325 32 
 
 Queens Borough G. & E. Co., 2 P.S.C. (1st Dist.) N.Y. 544 
 
 63, 88, 146, 227 
 
 Racine Water Co., (Wis.) P.U.R. 1917-D 277 171 
 
 Railroad Comm. v. P. & 0. C. R. Co., 63 Mo. 269 16
 
 TABLE OF CASES 249 
 
 Railroad Comm. of Louisiana v. Cumberland T. & T. Co., 212 U.S. 
 
 414, 53 L. ed. 577 216 
 
 Railroad Passenger Rate Case, (Mass.) P.U.R. 1915-B 362 33 
 
 Reagan v. Farmers' Loan & Trust Co., 154 U.S. 363, 14 Sup. Ct. 180, 
 
 38 L. ed. 1014 20, 55, 51, 58, 99, 221 
 
 Reagan v. Mercantile Trust Co., 154 U.S. 413 55 
 
 Redondo Beach, City of, In Re, (Cal.) 1915-B 429 154 
 
 Rhinelander v. Rhinelander L. Co., 9 W.R.C.R. 406 156 
 
 Rich v. Biddeford & S. W. Co., (Me.) P.U.R. 1917-C 982 134 
 
 Ripon v. Ripon Light & Water Co., 5 W.R.C.R. 1 134 
 
 Rippe v. Black, 56 Minn. 108 21 
 
 Rogers Park Water Co. v. Fergus, 178 111. 571 20 
 
 Roundup v. Roundup Coal Mine Co., (Mont.) P.U.R. 1916-D 
 
 393 170 
 
 Salem Tel. Co., In Re, (S. Dak.) P.U.R. 1919-B 734 136 
 
 Salinas City v. Coast Valley G. & E. Co., (Cal.) P.U.R. 1915-B 460 
 
 166, 199 
 San Diego Consolidated G. & E. Co., In Re, (Cal.) P.U.R. 1917-A 
 
 930 . 134 
 
 San Diego L. & T. Co. i>. Jasper, 110 Fed. 702! ........... '. 58 
 
 San Diego L. & T. Co. v. Jasper, 189 U.S. 439, 23 Sup. Ct. 571, 47 
 
 L. ed. 892 118, 120, 131, 145 
 
 San Diego L. & T. Co. v. Nat'l City, 74 Fed. 79 58 
 
 San Diego L. & T. Co. v. Nat'l City, 174 U.S. 739, 19 Sup. Ct. 804, 
 
 43 L. ed. 1154 20, 58, 71, 72, 119, 145 
 
 San Diego W. Co. v. San Diego, 118 Cal. 556, 50 Pac. 633 
 
 63, 110, 134, 144 
 
 San Gabriel Valley Water Co., (Cal.) P.U.R. 1916-B 895 134, 154 
 
 San Joaquin v. Stanislaus County, 191 Fed. 875 177 
 
 San Joaquin & K. R. Canal & Irrigation Co. v. Stanislaus Power & L. 
 
 Co., 233 U.S. 454, 58 L. ed. 1041 154 
 
 San Joaquin L. & P. Corp. v. R. Comm., (Cal. Sup. Ct.) P.U.R. 
 
 1917-E 37 156 
 
 San Jose Water Co., In Re, (Cal.) P.U.R. 1915-D 706 110 
 
 San Lorenzo Water Co., In Re, (Cal.) P.U.R. 1915-D 1091 154 
 
 Sandpoint v. Sandpoint Water & L. Co., (Idaho) P.U.R. 1915-F 445 
 
 134 154 204 
 
 Santa Cruz, City of, In Re, (Cal.) P.U.R. 1915-F 768 '....' 154 
 
 Shepard v. No. Pacific Ry. Co., 184 Fed. 765 110, 133 
 
 Simms v. Columbia Tel. Co., (Mo.) P.U.R. 1915-C 356 171 
 
 Simpson v. Shepard, 230 U.S. 352, 33 Sup. Ct. 729 73, 84, 123, 124 
 
 Sinking Fund Cases, 99 U.S. 700, 25 L. ed. 496 45 
 
 Slaughter House v. Crescent City L.S.L. Co., Ill U.S. 746, 16 Wall 
 
 36 20 
 
 Smyth v. Ames, 169 U.S. 466, 18 Sup. Ct. 418, 42 L. ed. 819 
 
 20, 58, 59, 72, 84, 90, 123, 144 
 
 Southern Minn. R.R. Co. v. Coleman, 94 U.S. 181 9 
 
 Spokane v. N. Pacific Ry. Co., 15 I.C.C. R. 376 136 
 
 Spring Valley W.W. v. San Francisco, 124 Fed. 574 63, 88 
 
 Spring Valley W.W. v. San Francisco, 192 Fed. 137 63, 88, 183 
 
 Spring Valley W.W. v. San Francisco, 165 Fed. 667 63, 101, 105, 190 
 
 Spring Valley W.W. v. Schottler, 110 U.S. 347, 4 Sup. Ct. 48, 24 L. 
 
 ed. 173 20, 45
 
 250 TABLE OF CASES 
 
 Springfield v. Springfield C. & E. Co., I.P.U.C. No. 2138, P.U.R. 
 
 1916-C 281 95, 99, 110, 112, 115 
 
 Stanislaus County v. San Joaquin & King's River Canal & Irrigation 
 
 Co., 192 U.S. 201, 26 Sup. Ct. 241, 48 L. ed. 406 121, 221, 222 
 
 Stark County Power Co., In Re, I.P.U.C. No. 6704 88 
 
 Stark County Tel. Co., In Re, 5 I.P.U.C. 63 89 
 
 State ex rel. v. Clausen, 116 Pac. 7 63 
 
 State ex rel. v. Savage, 65 Neb. 714, 91 N.W. 716 63, 79 
 
 State ex rel. R.R. Comm. v. Seaboard Air Line Ry. Co., 48 Fla. 129, 
 
 37 So. 314 84 
 
 State Journal Printing Co. v. Madison G. & E. Co., 4 W.R.C.R. 501 
 
 146, 169 
 
 State P.U. Comm. ex rel. v. Noble, 275 111. 121 38 
 
 State P.U.C. Comm. ex rel. v. Romberg, (111.) P.U.R. 1917-B 355 . . 38 
 Steenerson v. Gt. Northern Ry. Co., 69 Minn. 353, 72 N.W. 713 
 
 101, 110, 133, 146 
 
 Stewart v. G. Northern Ry., 65 Minn. 517 21 
 
 St. Louis & S.F. R.R. v. Gill., 156 U.S. 649, 39 L. ed. 567, 15 Sup. Ct. 
 
 484 20, 32 
 
 St. Louis & S.F. R.R. v. Mathews, 165 U.S. 1, 17 Sup. Ct. 243, 41 L. 
 
 ed. 611 20 
 
 St. Louis & S.F. R. Co. v. Hadley, 168. Fed. 317 79, 190 
 
 St. Louis R. Co. v. Minn., 186 U.S. 257 84 
 
 Stockton Terminal, In Re, 19 Com. L. 208 79 
 
 Stone v. Farmers' L. & T. Co., 116 U.S. 307, 6 Sup. Ct. 334 .. . 48, 51, 53 
 
 Stone v. Mississippi, 101 U.S. 814, 25 L. ed. 1079 20 
 
 Stone v. Wisconsin, 94 U.S. 181, 24 L. ed. 102 9 
 
 Sugar Pine R. Co., In Re, (Cal.) P.U.R. 1915-A 728 99 
 
 Superior Commercial Club v. Duluth St. Ry. Co., 12 W.R. C.R. 1 . 134 
 
 Talcott v. Pine Grove, 1 Flipp., (U.S.) 120 15 
 
 Taylor v. Northwest L. & W. Co., (Idaho) P.U.R. 1916-A 372 152 
 
 Terminal Taxicab Co., In Re, (D.C.) P.U.R. 1915-B 546 110, 174 
 
 Thayer v. Beaver Valley Water Co., (Pa.) P.U.R. 1916-E 962. . 134, 154 
 Theresa U.T. Co. v. E. Valley T. Co., (Wis.) P.U.R. 1917-E 387. . . 38 
 
 Tighe v. Clinton Tel. Co., 3 W.R.C.R. 117 133 
 
 Tilley v. S.F. & W. Ry., 5 Fed. 641 47 
 
 Tonopah & Tidewater R. Co., In Re, (Cal.) 22 A. T. & T. Co. Com. 
 
 Leaf. 1064 177 
 
 Tyrone Elec. Co., In Re, (111.) P.U.R. 1916-E 708 83 
 
 Union Gas & E. Co., 5 111. P.U.R. 205 230 
 
 Union P. R.R. v. P. Utilities Comm., (Kan.) P.U.R. 1915 -D 377.. 32 
 
 Union Pacific R. v. United States, 99 U.S. 402, 25 L. ed. 274 203 
 
 United States v. Kansas Pac. Ry. Co., 99 U.S. 459 203 
 
 Valley Natural Gas Co., (Cal.) P.U.R. 1918-C 218 
 
 Valparaiso Tel. Co., (Neb.) P.U.R. 1915-E 578 136 
 
 Vega S.S. Co. v. Consol. E. Co., 75 Minn. 308, 77 N.W. 973, 43 
 
 L.R.A. 843, 74 Am. St. Rep. 484 21 
 
 Venner v. Chicago City R.R. Co., 246 111. 170 20 
 
 Vogt & Linden Tel. Co., (Wis.) P.U.R. 1917-A 614 14
 
 TABLE OF CASES 251 
 
 Wabash, etc. R.R. v. Illinois, 118 U.S. 557 20 
 
 Warren L. & P. Co., 5 111. P.U.R. 72 230 
 
 Washburn v. Washburn Water Works Co., 6 W.R.C.R. 74 134 
 
 Washington & M.R. Co.. (D.C.) P.U.R. 1915-B 558 105, 169, 173 
 
 Westchester St. Ry. In Re, 3 N.Y.P.S.C. (2d Dist.) 286 80 
 
 Western Advance Rate Case, 20 I.C.C.R. 307 110, 146 
 
 Willcox v. Consolidated Gas Co., 212 U.S. 19, 29 Sup. Ct. 192, 53 L. 
 
 ed. 382 63, 64, 79, 88, 122, 145, 182, 192. 203, 222 
 
 Winona & St. Peter R.R. Co. v. Blake, 94 U.S. 181, 24 L. ed. 99. . . 9 
 Wisconsin Ry. Co. v. Jackson, 179 U.S. 287, 45 L. ed. 194, 21 Sup. 
 
 Ct. 115 33 
 
 Worcester v. R.R Co., 4 Metcalf 564 16
 
 INDEX
 
 INDEX 
 
 Abandoned property, 70, 129-32. 
 
 Accounting, 43. 
 
 Accounts, uniform, 43. 
 
 Accrued depreciation, 197, 198- 
 200, 215, 218. 
 
 Accruing depreciation, 197, 198, 
 199, 218. 
 
 Actual cost. See Original cost. 
 
 Actual investment theory. See 
 Actual value. 
 
 Actual value, 56, 113-19. 
 
 Adaptation, 175-77. 
 
 Additions and betterments, 28, 
 134-36, 208. 
 
 Adequacy of service, 15, 28, 40. 
 
 Adjacent land value, 139, 145. 
 
 Age of plant, 206-07. 
 
 Aims of regulation, 20-25, 27-44, 92. 
 
 Aims of valuation, 56. 
 
 Alvord's reproduction cost theory, 
 101-^04. 
 
 Amortization, 165. 
 
 Analogy. See Condemnation anal- 
 ogy- 
 
 Annuity method of estimating de- 
 preciation, 210-11. 
 
 Anti-monopoly regulation, 33-34. 
 
 Antiquated property, 129-32. 
 
 Appraisals, 94-96. 
 
 Appreciation, 141-45. 
 
 Architects' fees, 170. 
 
 Assessed value of land, 139-40. 
 
 Attempt to discredit original cost, 
 107-12. 
 
 Average buildings, 151-52. 
 
 Average prices. See Unit costs. 
 
 Ballast, 176. 
 
 Banks, regulation of, 12. 
 Basis of regulation, 1-26, 28. 
 Beginning of operations. See Or- 
 ganization costs. 
 Betterments, 28, 134-35, 137, 208. 
 Bonds: 
 
 discount on, 173-75; 
 
 disregarded in rate valuation, 
 61. 
 
 Book value, 91, 97. 
 
 Branch lines, return on, 32. 
 
 Bridges, regulation of, 10. 
 
 Brokerage, 173-74. 
 
 Buildings, valuation of, 151-53. 
 
 Buildings used only in part for 
 
 service, 153. 
 Business profits. See Return. 
 Bus lines, 18. 
 
 Canals, 10, 17. 
 Capitalization: 
 
 accounting and capitalization, 
 43; 
 
 consolidation, 43; 
 
 of earnings, 80; 
 
 over-capitalization, 91; 
 
 purchase and sale, 43; 
 
 regulation of, 43; 
 
 reorganization, 43; 
 
 valuation based on, 91, 92. 
 Capitalization of earnings, 80, 89. 
 Charges for service. See Rates. 
 Charters, early, 6. 
 Commercial value. See Exchange 
 
 value. 
 Commission Cases, 48-51. 
 Common law, 5, 10, 12, 46. 
 Communication service, public 
 
 character of, 18. 
 Comparative plant, 105-06. 
 Competition: 
 
 and appreciation, 141-43; 
 
 and speculation, 39-41 ; 
 
 as a regulatory force, 13, 34, 
 36-39; 
 
 duplication, 13, 17, 36; 
 
 effect on prices, 35-39; 
 
 fostered during anti-monopoly 
 period, 34; 
 
 reason for change to monop- 
 oly, 34-39; 
 
 regulatory power of, 14, 35; 
 
 waste of, 13, 17,36,57. 
 Compromise reoroduction theory, 
 
 106. 
 Condemnation, 63-73.
 
 256 
 
 INDEX 
 
 Condemnation analogy: 
 
 and going value, 64, 178; 
 
 application of, 63-73, 145; 
 
 growth of, 57-59, 74; 
 
 origin of, 57; 
 
 theory of, 57-59, 63-73. 
 Condemnation theory. See Con- 
 demnation analogy, Due pro- 
 cess, etc. 
 Condemnation value, 63-73. 
 Confiscation. See Due process. 
 Confusion in valuation, 45, 67, 76, 
 
 138-39. 
 Consolidation, 43. 
 Construction cost: 
 
 architects' fees, 170-71; 
 
 contingencies, 147-49; 
 
 contractors' profits, 172-73; 
 
 engineering fees, 161, 163, 165, 
 170-72; 
 
 insurance, 161, 170; 
 
 legal expense, 167; 
 
 multiples, 148-51; 
 
 organization expense, 166-67; 
 
 piecemeal construction, 175- 
 76; 
 
 promoters' profits, 167-68; 
 
 supervision, 163, 170-72; 
 
 taxes, 161, 170. 
 Construction period, 168-69. 
 Contingencies, 147, 148, 150. 
 Continuous service, 15, 28, 40. 
 Contractor's profit, 172-73. 
 Contracts, 152-54. 
 Corporations, 54. 
 
 Cost. See also Reproduction cost, 
 Original cost, etc. 
 
 rate valuation determines cost, 
 81. 
 Cost of production, 49, 56, 61, 72. 
 Cost of reproduction. See Repro- 
 duction cost. 
 Cost of service, 56, 81, 84, 85. 
 Circle. See Vicious circle. 
 Current repairs. See Maintenance. 
 
 Damages. See Multiples. 
 Deferred maintenance. See Depre- 
 ciation. 
 Depreciation: 
 
 a cost element, 197-98; 
 accrued, 197, 198, 199-200, 
 
 214-15, 218; 
 accruing, 197, 198, 200, 218; 
 
 and efficiency, 198-202; 
 
 and the courts, 202-04; 
 
 annuity method, 210-11; 
 
 buildings, 152; 
 
 Colorado theory, 213-15; 
 
 confusion with efficiency, 198- 
 202; 
 
 defined, 196; 
 
 diminishing balance method, 
 209-10; 
 
 estimated life, 206-07; 
 
 functional, 196-97; 
 
 intangibles, 288-89; 
 
 judicial holdings on, 202-04; 
 
 maintenance plan, 207; 
 
 miscellaneous methods, 212- 
 13; 
 
 of intangibles, 205-06; 
 
 physical, 196; 
 
 problem of, 198; 
 
 reserve for, 196, 215-18; 
 
 salvage value, 204-05; 
 
 sinking-fund method, 211-12; 
 
 straight-line method, 207-09; 
 
 theory of, 196, 198. 
 Depreciation of overheads, 165. 
 Depreciation reserve, 197-98, 215- 
 
 18. 
 Deterioration, 196. 
 Development expenses, 166-67. 
 Development of regulation, 4. 
 Difference between inventory, ap- 
 praisal, and valuation, 95. 
 Diminishing balance method of 
 
 depreciation, 209, 210. 
 Discarded property, 129-32. 
 Discounts. See Bond discounts. 
 Discrimination, 8, 29, 82. 
 Donations, 133-34. 
 Due process: 
 
 application to rate-making, 23, 
 49, 74; 
 
 Commission cases, 48-51; 
 
 confiscation, 23, 63-73; 
 
 Granger cases, 9, 45-48; 
 
 operation at a loss, 83; 
 
 theory of, 49-50. 
 Duplication, 13, 15, 17, 36-39. 
 
 Early charter provisions, 7. 
 Earnings capacity: 
 
 in purchase and sale cases, 
 88-90; 
 
 in rate cases, 49, 90.
 
 INDEX 
 
 257 
 
 Earnings, 49. 
 
 Economic factors in valuation, 
 
 77. 
 Economic management, reward for, 
 
 81, 229-31. 
 Economic value, 78, 81, 92. 
 Economist, sphere of, in valuation, 
 
 94, 95. 
 Efficiency: 
 
 and depreciation, 41, 198-202; 
 economic management, 41-42, 
 
 229-31; 
 false capitalization, 41; 
 necessity for, 41-42; 
 operating expenses, 41 ; 
 reward for, 41, 81, 229-30; 
 salaries, 42. 
 Electric plant as a utility, 19. 
 Emergency use, 131-32. 
 Eminent domain : 
 
 and rate-making, 63-73; 
 compared with police power, 
 
 66; 
 condemnation theory of val- 
 uation, 63-73. 
 Encumbrance of regulation, 11, 
 
 26, 82. 
 Engineer, sphere of, in valuation, 
 
 94. 
 Engineering costs, 161, 163, 165, 
 
 170-72. 
 Equally efficient plant, 105-07. 
 Established business, cost of. See 
 
 Overhead costs. 
 Estimated life, 206-07. 
 Estoppel to deny fair return, 86. 
 Excessive investment, 131-32. 
 Exchange value: 
 
 difference between rate and 
 
 exchange value, 81; 
 fair value not exchange value, 
 
 80-82; 
 limited by regulation, 92; 
 value defined, 77. 
 Expert witnesses as to land value, 
 
 138-39. 
 Express service, 18. 
 
 Facilities : 
 
 donated by consumer, 133, 
 
 135; 
 rules requiring installation, 41. 
 Factory system and laissez-faire 
 policy, 8. 
 
 Fair return: 
 
 allowance for surplus, 231 f 
 and the court, 220-22; 
 development of return ques- 
 tion, 220-22; 
 duplication in valuation and 
 
 return, 229-30; 
 economic management, 230- 
 
 31; 
 elements involved in return, 
 
 222-23; 
 interest element, 223-25; } 
 rate of return, 227-28; 
 risk element, 225; 
 surplus, 231; 
 
 valuation and the return, 220. 
 Fair value. See also Valuation, 
 Original cost, etc. 
 a legal concept, 45, 81 ; 
 and regulation, 45-76; 
 as a test for individual rates, 
 
 73; 
 condemnation analogy, 57-59, 
 
 63-73; 
 confusion regarding, 45, 67, 74; 
 for capitalization, 42, 79; 
 for purchase and sale, 42, 79, 
 
 88-90; 
 for rate-making, 81-88; 
 for taxation, 79-80, 82; 
 investment theory of, 87-88, 
 
 113-19; 
 meaning of value, 77-79, 82; 
 not exchange value, 80-81 ; 
 of service, 72; 
 rate-making value, 81-88; 
 theories of value, 96; 
 varying uses of, 79-80. 
 Ferries, regulation of, 10. 
 Fifth Amendment, 49. 
 Fillings, 141. 
 
 Financial regulation, 42-43. 
 Formula, none for valuation, 125. 
 Fourteenth Amendment, 28, 44, 
 46, 49, 63-73, 92, 94, 98, 144, 145, 
 220. 
 Franchises, early policy regarding, 
 
 7. 
 Franchise value, 189-93. 
 Functional depreciation, 196, 203. 
 Future : 
 
 construction for, 129, 131-32; 
 requirement of, 131; 
 water rights held for, 154.
 
 258 
 
 INDEX 
 
 Gas plant, a utility, 19/ 
 Gifts, 183, 185. 
 Going-concern value, 180-81. 
 Going value: 
 
 and courts, 188-89; 
 
 and exchange differential, 181- 
 82; 
 
 and return, 230; 
 
 comparative plant estimate, 
 186-88; 
 
 good-will, 182-84; 
 
 in general, 179-81 ; 
 
 methods of estimating, 179; 
 
 not allowed as a separate ele- 
 ment, 81, 186; 
 
 origin of dispute, 178; 
 
 past deficits, 184-86; 
 
 Wisconsin rule, 184-86, 187. 
 Good-will, 182-84. 
 Government control, 21-25. 
 Government, powers of. See Rate- 
 making power. 
 Governmental function theory of 
 
 regulation, 19-25, 8£. 
 Grading, 141. 
 Granger cases, 9, 45-48. 
 Granger movement, 8. 
 Grants, 7. 
 
 Heating service, public nature of, 
 19. 
 
 Highways, comparison of railways 
 with, 10. 
 
 Hypothesis. See Reproduction cost. 
 
 Hypothetical expenses. See Re- 
 production cost. 
 
 Identical plant. See Substitute 
 plant. 
 
 Improvements. See Additions and 
 betterments. 
 
 Inadequacy. See Functional de- 
 preciation. 
 
 Income. See Return. 
 
 Individualism, 4, 7. 
 
 Individual rates, 73. 
 
 Inns, 17. 
 
 Insurance, 161, 170-71. 
 
 Insurance companies, regulation of, 
 12. 
 
 Intangible property: 
 adaptation, 176-77; 
 architects' fees, 170; 
 attitude of court, 188-89; 
 
 ballast, 176-77; 
 
 comparative plant estimate, 
 
 186-88; 
 contingencies, 147-48; 
 defined, 161; 
 
 depreciation of, 165, 205-06; 
 discount on bonds, 173-75; 
 engineering, 170-72; 
 exchange differential, 181-83; 
 franchise value, 189; 
 going-concern value, 179-81; 
 going value, 177, 189; 
 good-will, 182-84; 
 insurance, 170; 
 interest during construction, 
 
 167-70; 
 multiples, 148-51; 
 organization expenses, 166- 
 
 67; 
 outlined, 162; 
 overhead charges, 161-65; 
 past deficits, 184-88; 
 piecemeal construction, 175- 
 
 79; 
 promoters' profits, 166-67; 
 seasoning, 176; 
 solidification, 175-79; 
 superintendence and engineer- 
 ing, 170-72; 
 taxes, 170; 
 
 Wisconsin rule, 184-86. 
 Interest during construction, 161, 
 
 167-70. 
 Interest element of return, 223- 
 
 25. 
 Inventory, 94-96. 
 Invested surplus, 135-38. 
 Investment, basis of valuation, 
 86-88. 
 
 Jeffersonian dispute, 50. 
 
 Judicial legislation, 49-50. 
 
 Judicial limitation on rate-making. 
 See Judicial review. 
 
 Judicial recognition of public in- 
 terest, 15-20, 29-31. 
 
 Judicial review, 50, 53, 55. 
 
 Junk value, 132. 
 
 Jurisdiction of court in rate cases, 
 50, 59. 
 
 Laissez-faire policy: 
 
 effect on court decisions, 6, 
 49;
 
 INDEX 
 
 259 
 
 in early American law, 6; 
 in general, 6, 27, 49; 
 Munn case limits, 11; 
 reason for, 7. 
 Land grants. See also Public aid. 
 not valued, 71; 
 trust theory applied to, 71. 
 Land value: 
 
 appraiser method, 138, 139; 
 appreciation, 141-46; 
 buildings on the land, 140-41; 
 local expert method, 138-39; 
 market value, 139, 146; 
 original cost appraisal, 140; 
 reproduction cost appraisal, 
 
 146-51; 
 sales method, 138-39. 
 Legal expenses, 161. 
 Legal monopoly, 14. 
 Legislative power over rates, 49- 
 
 50, 59-63, 74. 
 Life of plant, 205-06. 
 Lighting service, public nature of, 
 
 19. 
 Limitation on social side of regula- 
 tion, 29-33. 
 Limitation on original cost, 56, 72. 
 Limitation on rate of return, 227- 
 
 28. 
 Limited necessities, supplying is a 
 
 public service, 19. 
 Local expert land valuation, 138- 
 
 39. 
 Losses, 184-86. 
 
 Mains, pavement over. See Paving. 
 Maintenance, 28, 197-98, 207. 
 Maintenance plan of depreciation, 
 
 207. 
 Management, 41-42, 81. 
 Market value, 61, 90-91. 151. 
 Market value of securities, 61, 73, 
 
 90-91. 
 Maximum rate laws, 33, 56. 
 Methods of valuation, 90. 
 Minimum limit on rate-making, 
 
 56, 61. 
 Monopoly : 
 
 anti-monopoly regulation, 12, 
 
 33-34; 
 as basis for regulation, 11-15; 
 does not create utility, 12; 
 does not explain purpose of 
 regulation, 13; 
 
 early regulation of, 12; 
 
 effect of, 13; 
 
 government regulation of, 12; 
 
 legal, 13; 
 
 natural, 14 n.; 
 
 price, 12, 17; 
 
 profits, 12; 
 
 reason for acceptance of, 14, 
 36-39; 
 
 recognition of, 34-36; 
 
 restraint of, 12. 
 Monopoly price, 12. 
 Monopoly profits, 12, 23, 34. 
 Multiples, 148-51. 
 Munn case, 9, 11, 15. 
 
 Natural monopoly, 14 n., 36. 
 Necessity for regulation, 15. 
 Non-competitive rates, 33. 
 Non-operating property, 129-32. 
 Normal cost theory,_106-07. 
 Normal price, 35. 
 
 Obsolescence, 196. , 
 
 Operation at a loss, 83. 
 Options. See Contracts. 
 Organization cost, 166-67. 
 Original cost : 
 
 actual cost, 56; 
 
 attempt to discredit, 107-12; 
 
 attitude of courts toward, 110- 
 12; 
 
 book value, 97; 
 
 defined, 97-99; 
 
 difficulty in applying, 108; 
 
 estimation of, 109; 
 
 limitation on, 56, 72; 
 
 narrow use of term, 91; 
 
 objected to by utilities, 107- 
 12; 
 
 reasonable cost, 56; 
 
 Smyth v. Ames, 109-12; 
 
 theory of, 97-99. 
 Original-cost-to-date, 98. 
 Over-capitalization, 92, 147. 
 Overhead charges: 
 
 adaptation and solidification, 
 175-77; 
 
 architects' fees, 170; 
 
 attitude of court, 188-89; 
 
 ballast, 176; 
 
 book value of overheads, 161; 
 
 comparative plant estimate, 
 186-88;
 
 260 
 
 INDEX 
 
 contingencies, 147-49; 
 contractors' profits, 171-73; 
 depreciation of overheads, 165; 
 discount on bonds, 173-75; 
 duplication in allowance for 
 
 overheads, 161, 162-63; 
 engineering fees, 161, 163, 165, 
 
 170-72; 
 franchise value, 189-93; 
 going-concern value, 179-81; 
 going value, 177-79; 
 going value and courts, 188- 
 
 89; 
 going value and exchange 
 
 differential, 181-82; 
 going value, Wisconsin rule, 
 
 184-86; 
 good-will, 182-84; 
 insurance, 161, 170; 
 interest during construction, 
 
 161, 167-70; 
 legal expenses, 161; 
 list of overheads, 162-63; 
 multiples, 148-51; 
 organization expenses, 166; 
 past deficits, 184-86; 
 piecemeal construction, 175- 
 
 76; 
 promoters' profits, 166-67; 
 reproduction cost estimate of, 
 
 161, 164-65; 
 seasoning, 176; 
 solidification and adaptation, 
 
 175-77; 
 supervision, 163, 170-72; 
 taxes, 161, 170; 
 Wisconsin rule for going value, 
 
 184-86. 
 
 Past deficits, 184-86. 
 Past profits. See Profits. 
 Patrons of Husbandry, 9. 
 Paving: 
 
 actual cost, 157; 
 
 not actually cut, 157-58; 
 
 original cost appraisal, 157- 
 
 58; 
 reproduction cost appraisal, 
 113, 157-59. 
 Physical depreciation, 196. 
 Physical plant. See Tangible prop- 
 erty. 
 Piecemeal construction, 164-65, 
 172, 175-76. 
 
 Pioneer risk, 226-27. 
 
 Pipe lines, 18. 
 
 Pipes, paving over. See Paving. 
 
 Pleading and practice in rate cases, 
 
 69. 
 Police power: 
 
 cannot be contracted away, 16; 
 
 compared with eminent do- 
 main, 66, 75; 
 
 effect on property, 4; 
 
 extent of, 66, 70; 
 
 limitation upon, 66, 70, 74; 
 
 necessary, 16; 
 
 negative character of, 27; 
 
 public interest, 4, 15; 
 
 purpose of, 19-20; 
 
 restrictive nature of, 27; 
 
 similar to eminent domain, 66. 
 Possession distinguished from prop- 
 erty rights, 4. 
 Preliminary expenses, 161, 165-73. 
 Present value. See Fair value, etc. 
 Price economics, 7. 
 Private ownership, 4, 31, 33, 84. 
 Private property. See Property. 
 Profits: 
 
 and return, 224; 
 
 and surplus, 135; 
 
 limits on, 11, 82; 
 
 past profits, 82; 
 
 public interest in, 11; 
 
 regulation of, 33, 56. 
 Promotion, 7. 
 
 Promotion expenses, 166-67. 
 Property : 
 
 abandoned, 70; 
 
 acquired from surplus, 134- 
 38; 
 
 acquired without cost, 133-34; 
 
 and the state, 3, 19; 
 
 appreciation, 141—46; 
 
 a social institution, 4, 11; 
 
 buildings, 151-53; 
 
 bundle of rights theory, 3, 11, 
 143; 
 
 constitutional safeguards, 28, 
 44, 46, 49, 143-44; 
 
 contracts, 153; 
 
 definition of private property, 
 3; 
 
 destroyed by regulation, 27; 
 
 distinguished from possession, 
 4; 
 
 donated, 133-36;
 
 INDEX 
 
 261 
 
 economic status of private 
 property, 3; 
 
 encumbrance of control, 11, 
 82; 
 
 held for emergency, 131; 
 
 held for future needs, 132; 
 
 intangible, 129; 
 
 laissez-faire doctrine, 6-7; 
 
 land, 138; 
 
 legal status of, 3, 83; 
 
 limitation on use of, 3, 4, 11; 
 
 not used or useful, 70, 129- 
 32; 
 
 origin of, 4; 
 
 original cost, 140-41; 
 
 paving, 157-59; 
 
 private, 3-5; 
 
 property rights, 3-5; 
 
 public interest in, 4, 11, 16, 
 29-31; 
 
 rate-making a limitation on, 
 11, 27, 82; 
 
 regulation and, 5; 
 
 sanction of government nec- 
 essary to, 4; 
 
 social side of, 4, 11, 16 ; 
 
 two sides of, 4, 11; 
 
 uses of, 5; 
 
 water rights, 153-56. 
 Property rights, 3-5. 
 Prospecting, 161. 
 Provision for future, 132. 
 Public aid, 7. 
 
 Public interest, 3, 15-20, 29-31. 
 Public utilities: 
 
 abuse of privileges, 7-9; 
 
 ancient utilities, 17; 
 
 classified separately by com- 
 mon law, 5; 
 
 development of, 5; 
 
 early need of, 6; 
 
 early utilities, 6; 
 
 governmental nature of, 19- 
 25; 
 
 importance of, 6; 
 
 interest not antagonistic to 
 that of public, 29; 
 
 laissez-faire policy, 6; 
 
 monopolistic, 14; 
 
 need for, in early days, 6; 
 
 regulation of . See Regulation; 
 
 under common law, 6. 
 Purchase and sale: 
 
 amortization of excess, 42; 
 
 partial sale, 42; 
 
 price limited by rate value, 
 
 42, 82; 
 regulation of, 42; 
 sale price, 42; 
 valuation for, 79, 82. 
 Purpose of regulation, 23, 27-44, 
 
 60, 73. 
 Purpose of reproduction cost ap- 
 praisal, 105-07. 
 
 Rate basis. See Valuation for rate- 
 making. 
 Rate-making power: 
 
 aim of, 29, 83; 
 
 Commission cases, 48-51; 
 
 Granger cases, 9; 
 
 limitation on, 29-33, 74, 83; 
 
 limitation on other regulation, 
 28; 
 
 limitation on property, 27, 82; 
 
 Regan case, 55-57; 
 
 valuation as base of, 81-88. 
 Rate of return: 
 
 adjustment to social needs, 32; 
 
 allowance for surplus, 231; 
 
 and the courts, 221-22; 
 
 branch line, 31; 
 
 constitutional requirement, 83; 
 
 development of return ques- 
 tion, 221-22; 
 
 duplication in valuation and 
 return, 229-30; 
 
 economic management, 81; 
 
 elements involved in return, 
 222-23; 
 
 interest element, 223-25; 
 
 limits on return, 227-28; 
 
 must be met on each rate, 
 31-33, 73; 
 
 rate of return, 32, 83, 227-28; 
 
 risk element, 225; 
 
 surplus, 230; 
 
 valuation and the return, 83, 
 220. 
 Rate regulation, 29-33, 41, 92. 
 Rate value, 83-88. 
 Rates, 23, 29-33. 
 Real estate. See Land value. 
 Reasonableness : 
 
 arbitrary, 23, 83; 
 
 legislative question, 23, 59, 61; 
 
 original cost, 56, 61, 72; 
 
 test of, 23, 84, 220-21.
 
 262 
 
 INDEX 
 
 Rebates, 8, 29. 
 
 Recognition of regulated monop- 
 oly, 34-36. 
 Regulation : 
 
 accounting, 43; 
 
 aim of, 23, 27, 44, 83; 
 
 an encumbrance on private 
 property, 11, 26, 82; 
 
 basis of, 11, 23, 28; 
 
 competition, 35, 36-39; 
 
 destructive, 27; 
 
 early, 4; 
 
 effect on private property, 
 4, 5, 26, 27-28; 
 
 encumbrance on private prop- 
 erty, 11, 26, 82; 
 
 financial, 28, 42-43; 
 
 limitation on. See Rate-mak- 
 ing power; 
 
 monopoly as basis, 11; 
 
 negative in character, 27; 
 
 public interest, 4, 11, 29-31; 
 
 purpose of, 23, 27-44, 60, 71; 
 
 rate of return, 32; 
 
 rates, 28, 29, 33, 45; 
 
 restrictive, 5, 26, 27; 
 
 service requirements, 28; 
 
 social side of, 4, 29-31; 
 
 speculation, 39-41. 
 Renewals, 198, 206-07. 
 Reorganization, 43. 
 Repairs, 28, 198, 206-07. 
 Replacement cost. See Reproduc- 
 tion cost. 
 Replacements. See Depreciation. 
 Reproduction cost: 
 
 a check on original cost, 105; 
 
 Alvord's theory of, 102-04; 
 
 Ames case theory, 104 ; 
 
 attitude of court, 111-12, 119- 
 24; 
 
 compromise theory, 106-07; 
 
 defects of, 112-13; 
 
 development of the theory, 
 100-05; 
 
 economic value, 81-82; 
 
 market value, 81-82; 
 
 Minnesota Rate case, 123-24; 
 
 normal cost, 107; 
 
 origin of the reproduction 
 theory, 92, 99; 
 
 paving, 112-13, 157-59; 
 
 purpose of reproduction cost 
 appraisal, 105-07; 
 
 strained theory, 111-13; 
 
 substitute plant, 105-06; 
 
 Supreme Court and, 119-24; 
 
 three theories of, 99-100. 
 Reserve for depreciation, 206-07, 
 
 215-18. 
 Return. See Rate of return. 
 Reward for economic management, 
 
 81. 
 Risks of business, 142, 225-26. 
 Road bed. See Solidification. 
 Rules of valuation, 95, 179. 
 
 Sales and assessor method, 138-39. 
 
 Sales method of valuing land, 138- 
 39. 
 
 Salvage value, 204. 
 
 Saving-over-coal value of water 
 rights, 155-56. 
 
 Scrap value. See Salvage value. 
 
 Seasoning, 176. 
 
 Securities, 43. 
 
 Service, 15, 28, 40. 
 
 Service, value of, 72, 83-85. 
 
 Services, installed by consumer, 
 134-35. 
 
 Sinking-fund method of deprecia- 
 tion, 211-12. 
 
 Social sacrifice principle, 57. 
 
 Social side of private property, 4, 
 11, 16. 
 
 Social side of regulation, 4, 11, 16, 
 29-33. 
 
 Social welfare, 29-33. 
 
 Solidification, 176-77. 
 
 Speculation, 8, 39-41, 142. 
 
 Springs. See Percolating waters. 
 
 Standard of living, 30. 
 
 State aid, 7. 
 
 State regulatory power. See Police 
 power. 
 
 Stocks. See Capitalization. 
 
 Storage, 19. 
 
 Straight-line method of deprecia- 
 tion, 207-09. 
 
 Subsidies, 31. 
 
 Substitute plant theory, 105-06. 
 
 Substitute service, 36. 
 
 Superintendence, 163, 170-72. 
 
 Surplus : 
 
 allowance for, in return, 231; 
 invested, 135-38; 
 property acquired from, 134, 
 135-38.
 
 INDEX 
 
 2G3 
 
 Tangible property: 
 
 acquired from surplus, 134,138; 
 
 acquired without cost, 133-38; 
 
 appreciation, 141-46; 
 
 buildings, 151-53; 
 
 contracts, 153; 
 
 defined, 129; 
 
 land, 138; 
 
 riot used or useful, 129; 
 
 original cost, 140-41; 
 
 paving, 157-59; 
 
 reproduction cost, 146-51; 
 
 water rights, 152-57. 
 Taxes, 161, 170. 
 Tax value, 79. 
 
 Telegraph and telephone, 18. 
 Temporary structures, 141. 
 Threat prices, 12. 
 Title not taken in rate-making, 66. 
 Transportation service, public char- 
 acter of, 19. 
 Transportation system, importance 
 
 of, 6, 17. 
 Trust theory applied to land 
 
 grants, 71. 
 Turnpike, regulation of, 10, 18. 
 
 Unearned increment. See Appre- 
 ciation. 
 Unit costs, 35. 
 Unused property, 70, 95, 129-32. 
 
 Valuation. See also Overhead 
 charges, Depreciation, etc. 
 actual investment theory, 56, 
 
 113-19; 
 a judicial theory, 45; 
 a legal concept, 45, 81 ; 
 and economics, 77; 
 and regulation, 45-76; 
 an encumbrance, 27, 82-83; 
 appraisal, 94; 
 
 as a test for individual rates, 73; 
 as cost finding, 81; 
 capitalized earnings, 82; 
 condemnation analogy, 57-59, 
 
 63-73, 70; 
 confusion in, 45, 67, 78; 
 destructive effect of, 27, 83; 
 development of, 52, 56, 74-76; 
 economic features of, 57, 80- 
 
 82, 94-95; 
 engineering features of, 94; 
 exchange value, 78, 80-81, 82; 
 
 fair value, 80-81; 
 
 final valuation, 94-96; 
 
 for capitalization, 79; 
 
 for purchase and sale, 79, 82, 
 87-90, 191-93; 
 
 for rate-making, 79, 81-88, 
 191-93; 
 
 for taxation, 79-80, 82, 191; 
 
 growth of, 74; 
 
 inventory, 94-100; 
 
 investment theory, 86-87, 154, 
 113-19; 
 
 legal features, 94; 
 
 market value, 82; 
 
 meaning of value, 77-79; 
 
 methods, 90-92; 
 
 objective value, 78; 
 
 of reproducible objects, 99; 
 
 origin of valuation, 56; 
 
 original cost, 97-99, 107-15; 
 
 practice, 96; 
 
 purpose of, 71; 
 
 rate-making value, 81-88; 
 
 reproduction cost, 99-107, 
 112-13, 119-24; 
 
 steps in, 94; 
 
 subjective value, 78; 
 
 theories of value, 96; 
 
 varying uses of, 79-80. 
 Value: 
 
 defined, 78; 
 
 economic value, 78, 80-81, 92; 
 
 kinds of, 79; 
 
 legal value, 80-81. 
 Value of property. See Fair value, etc. 
 Value of service, 72, 81, 84-85. 
 Vested rights. See Due process. 
 Vicious circle, 64, 82. 
 
 Warehouses, regulation of, 10-11, 
 
 19, 45. 
 Waste of competition, 13, 17, 36, 57. 
 Water power. See Water rights. 
 Water rights, 152-56. 
 Waterways, 17. 
 
 Water work, public character of, 17. 
 Wear, 197. 
 Wells, public, 17. 
 Wharfinger, public nature of his 
 
 service, 19. 
 Wisconsin rule for going value, 
 
 184-86. 
 Working capital, 161, 193-94. 
 Worth of service, 57, 83, 84-85.
 
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