The engineer's activity in public affairs — Public utility commissions and franchise valuations

A paper to be presented at the 227th meeting of the American Institute of Electrical Engineers, New York, April10, 1903.

Copyright 1908. By Α. I . Ε. E . (Subject to final revision for the Transactions.)

T H E E N G I N E E R ' S A C T I V I T Y IN P U B L I C A F F A I R S -P U B L I C U T I L I T Y COMMISSIONS A N D F R A N C H I S E

V A L U A T I O N S

BY H E N R Y FLOY

Americans are, in a mild way, extremists. They start for the goal with such impetuosity and zeal that they often overrun the mark and then have to return to it. This is what is now happening to public opinion with reference to the corporations. No language is strong enough to express the public condemnation of corporate mismanagement, usurpation of power,-and larceny of funds which have recently been committed. On the other hand, all public utility corporations are not b a d ; and the engineer, knowing this, should be among the first to oppose the illogical, unreasonable condemnation of our present commercial system which causes a loss of the confidence on which our business relations are founded, and results in weakening the foundations of our whole economic structure.

As President Woodrow Wilson has truly said : S c a t h i n g i n d i c t m e n t s of our p re sen t i n d u s t r i a l a n d po l i t i ca l cond i t i ons

a r e w h a t we a r e suffer ing from a t t he p re sen t m o m e n t a n d t h e y a r e t o b e offset, no t b y o the r s c a t h i n g i n d i c t m e n t s , b u t b y a v e r y c a l m a n d se l f -posses sed e x a m i n a t i o n of a c t u a l cond i t ions of t h ings . W h a t we need a t p r e sen t is no t h e a t b u t l igh t .

As a matter of fact, public sentiment is now undergoing a reaction; the American sense of right and fair-play is winning. The pendulum has reached its extreme position and is starting to swing back. The excesses in which the public mind has been indulging, indicated by the cry for indiscriminate municipal ownership, governmental and socialistic management, are being replaced by a more sane demand for control and regulation.

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352 FLOY: THE ENGINEER'S ACTIVITY [Apr i l 10

I t is beginning to be recognized that a corporation must not only serve the public but also the stockholders; that the public cannot be served by corporations unless the stockholders receive a return on their investment concomitant with the risk; that capital cannot be compelled to invest - on terms unacceptable to it. This change of sentiment, however, does not mean, as is clearly evident to the well-informed engineer, that the public will ever again return to its former laissez faire policy toward corporations.

J u s t at this time, during this important readjustment of relations between the public and the corporations, it is proper, yes necessary, that the engineer should pause to consider the lessons to be learned from recent experience, formulate his opinions for the future, and thus be the better prepared to cooperate in ending the present feeling of unrest and antagonism and share in the successes of the new advance which is sure to begin soon. Although by education, training and experience the engineer is presumably well-balanced and not excitable, he may nevertheless be influenced by popular sentiment or the demands of the corporations or financiers. During this transition stage especially, when the demands upon his time are restricted, he should take the opportunity to verify his opinions, reestablish his conclusions, and calmly determine his future line of action.

With these thoughts in mind, this paper has been prepared to serve as an introduction to a discussion which it is hoped will help to a crystallization and unification of the ideas of the members of the Institute on but three, of many similar important nontechnical questions now demanding the serious consideration of broad-gauge engineers ; namely, activity of engineers in public affairs, public utility commissions, and franchise valuations. The author's comments must not be taken as an at tempt wholly to cover the subjects touched upon, or to reach conclusions which may not require modification, as the questions considered could very properly occupy the attention of the Institute at more than one session and they present viewpoints almost as diverse as is its membership.

Activity of Engineers. Considering the importance of the real work done by the engineer in the recent commercial development of this country, the comparatively unimportant public part taken by him is rather striking. His inconspicuous-ness can probably be accounted for by

(a) His keen interest in the purely scientific aspect of the

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enterprises with which he is connected; with him a " blunder is a crime The engineer, like the teacher or the ecclesiastic, has a certain love for his profession which absorbs and recompenses him, in a degree, independently of monetary reward or fame.

(b) His natural hesitancy in pressing his own claims to recognition. Most lawyers or politicians are ready speakers, used to argument, and therefore, by profession trained to make their own case a strong one.

(c) His lack, in the past, of a broad, general education, especially along the lines of history, political economy, and what, Dr. Humphreys, of Stevens Institute, in a recent address, called " business engineering " . A narrow, purely technical training does not conduce to a broad, liberal consideration of any subject.

(d) His too frequent inability tc speak fluently in public. The engineer does much of his work individually, quietly, on paper, so that he often becomes embarrassed when called to express his opinion from the platform.

As a result of these limitations the engineer has hardly received the public recognition which would be expected. Perhaps the most striking recent illustration of this was in the appointments made to the two Public Utilities Commissions of the State of New York, which included fourteen high-class, well-paid officials. Of this number only one has had a technical training, although in the hands of these commissioners are placed, with almost despotic power, the affairs of large engineering enterprises in the State of New York, estimated to be valued at about $3 ,500 ,000 ,000 . This exception is the more striking when it is considered that the same governor, in naming the Hepburn Commission to inquire into and report with recommendations as to the condition of banks, financial affairs, and their improvement, selected bankers; and, when a commission was named to consider and make recommendations with regard to the Torrens system of registration of land titles, the commission was almost entirely made up of men prominent in real estate matters. Mr. George W. Perkins, in a recent address, referring to a commission to have national supervision of railroads, said:

I t shou ld b e in t h e h a n d s of e x p e r t s . A r a i l r o a d c o m m i s s i o n , for ins t a n c e , s h o u l d b e c o m p o s e d of r a i l r o a d m e n w h o c a n d e a l w i th t he q u e s t i o n a r i s i n g in a p r a c t i c a l w a y . T h i s k i n d of e x p e r t , h i g h - m i n d e d s u p e r -

354 FLOY: THE ENGINEER'S ACTIVITY [Apri l 10

v i s ion wou ld no t b e o p p o s e d b y t h e b u s i n e s s i n t e r e s t s of t h e c o u n t r y . W h a t t h e y d r e a d is un in te l l igen t , i nexpe r i enced a d m i n i s t r a t i o n .

Mr. Perkins but expresses the accepted opinion that experts are the proper parties to have supervision of matters in which they are specialists. Even the New York State Court of Appeals, in a recent decision relating to the constitutionality of the statute creating a commission to determine rates, says :

T h a t t h e m o s t a p p r o p r i a t e m e t h o d ( s p e a k i n g f rom a p rac t i ca l , no t n e c e s s a r i l y c o n s t i t u t i o n a l po in t of v i ew) is t h e c rea t ion of a c o m m i s s i o n or b o d y of e x p e r t s t o d e t e r m i n e t h e p a r t i c u l a r r a t e s h a s been s a i d s e v era l t i m e s in t h e op in ions r e n d e r e d b y t h e S u p r e m e Cour t of t h e U n i t e d S t a t e s in t h e v a r i o u s r a i l r o a d c o m m i s s i o n c a s e s a n d in t h o s e of S t a t e c o u r t s .

I t is well known that the House of Lords in England, when it sits as a Court of Appeals, has the cases submitted to its law members, which would seem to be the only rational practice. Contrary to such general belief, the opinion prevailing in selecting the^ New York State commissioners, as indicated by their appointment, was that if they possessed unquestioned integrity there existed no special reason for naming men experienced in handling engineering or transportation questions. This has resulted in the necessity of hiring engineering subordinates, which increases expenses and decreases direct responsibility, because the advice of more or less independent experts reporting on matters of detail is quite different in value from the advice given by a technical member of a board identified with its policy and responsible to the public for the discharge of his obligations. Hired experts can never be made to shoulder the responsibility for a decision rendered by a commission composed wholly of men untrained in public utility affairs and perhaps unable fully to appreciate the technical effect of their orders.

I t is noteworthy that much of the work of the commissions is divided, one member investigating one question and a different membar another. With two or three commiss'oners as engineers, the engineering questions would naturally devolve upon these members, and they could solve them much more quickly and unequivocally than could politicians, lawyers, or business men unacquainted with even the terms involved, to say nothing of understanding the practical conditions under which a lighting corporation, or steam or electric railway company, must operate. A perusal of the minutes of the hearings held before state commissions will convince any unprejudiced person that a disproportionately large amount of evidence

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and testimony is submitted, with consequent unnecessary financial expense and consumption of time for the purpose of explaining terms, apparatus, and methods of operation and expenditure to commissioners who, in general, should be acquainted with the matters being considered. This and similar evidence surely indicates that the efficiency of the commissions is largely reduced by lack of proper make-up. For this condition of affairs the engineers themselves are partly to blame.

The antiquated notion that every engineering expert is unable to appreciate any question outside of its purely technical significance is disproved by the fact that the success of the engineer is often based on a liberal education with wide experience, giving him a capacity" for proper consideration not only of technical but also of commercial and political factors that enter engineering undertakings, and also by the fact that the administrative and executive staffs of many of our largest and progressive organizations are being constantly recruited from the engineering profession. To become president of the Pennsylvania Railroad, judging from precedent, one must have, in addition to other qualifications, both a technical education and practical experience in engineering work.

B y reason of the work and position of the engineer in the business and technical world, is it not reasonable to expect that at least one-half of the membership of the public utility commissions, being named from time to time throughout the country, should be composed of experienced, broad-gauge engineers. I venture to prophesy that as public service commissions become more common, they will be constituted more and more of men drawn from the ranks of those having practical experience with the work to be undertaken. In fact, I can conceive of no more independent, dignified, influential or beneficent occupation in which an engineer can be engaged, and I believe the honor of the position will ultimately attract to it our most capable men whom now the monetary inducement will not interest. The present inertness of the profession in these matters is noticeable. Las t spring the writer personally sought to have the officials of some of our engineering clubs and societies develop sentiment looking to action on the part of these respective organizations toward obtaining the appointment of some men of engineering experience on the New York State commissions, but only one organization acted. The public utility corporations themselves, represented by a number of executive officers in conference.


showed some interest in securing commissions capably constituted, but no definite results came from the conference. Even the labor unions have actively urged they be represented on the commissions, simply on grounds of self-interest, while the engineer, with especial qualifications for the work has too much pride to ask recognition, even with semi-altruistic motives. It is a hopeful sign that for the first time in its history the American Society of Civil Engineers recently memoralized Congress, urging legislation for the preservation of our forests, a precedent which might well bs followed by the Institute.

The commercial importance of the engineer is steadily growing, and he should recognize the claims upon him to take part in public affairs and assume the responsibility more and more laid upon him, of leadership. His increasingly closer business relations with public matters and his reputation for integrity give his opinion and influence steadily greater weight in large affairs, which he should appreciate, accept, and respond to. While the engineer's work must always be professional, in a way judicial, and should always be accompanied by high moral sense, the successful engineer must nevertheless combine practical business qualifications with his scientific work. There can be no good engineer—in a broad sense—unless combined with his technical conclusions there is included such recognition of commercial conditions, as will thereby permit him to attain the worthy objects of his chosen profession with maximum efficiency.

Public utility commissions. The aggressive, almost insolent, and oftimes unfair attitude of some utility corporations has created an insistent demand for further and more direct control of operations than has been possible through the more usual form of legislative enactments. The American people are not, as a rule, over inquisitive as to somebody else's business, but when imposed upon, they do not hesitate to ascertain the why and wherefore. The result has been a publicity of corporation finances and affairs that now implies an obligation to afford the corporation legitimate protection in their business.

The necessity for regulation by the public arises, in the first place, because the exercise of franchise rights by certain corporations, while academically not exclusive, is nevertheless practically non-competitive; therefore, one of the ordinary checks arising through competition does not in such cases apply. Unlike the individual or ordinary business corporation, a public utilities corporation frequently cannot begin business without


being organized under special and specific laws. Such corporations may be granted unusual franchises; for example, the right of eminent domain, and are recognized as existing for service to the public in a manner, and with privileges entirely unique and distinct from those of ordinary business undertakings, and are therefore acknowledgedly subject to special regulation and control. Even ordinary business corporations which have no special privileges granted, if uncontrolled, may, as the result of unusual commercial acumen linked with a large aggregation of capital— illustrated for example, in the case of the so-called " trusts " — create a wrong which organized society will very properly step in and limit, control, or prohibit. Business trusts are in effect monopolies, because competition as a practical matter is out of the question, and hence regulation in their cases is also essentially necessary. The underlying principle of monopolies, cooperation, is a legitimate product of our present civilization ; it may be controlled but not prohibited.

In the second place, regulation of utility corporations competing for the same business is required from the very nature of the business itself. If they are allowed to compete fully and freely, experience indicates that they will ultimately engage in a war of annihilation, the expense of which is in the end borne by the security holder or the public. Up to a few years ago, political economists believed and argued that the only regulation required for all commercial operations was free and unrestricted competition:

B e c a u s e the e x p e r i e n c e of m a n k i n d h a d no t d e v e l o p e d e s sen t i a l m o n o p olies, a n d ' i t w a s be l i eved t h a t e v e r y p r o b l e m which wou ld a r i s e w o u l d b e s o l v e d b y g i v i n g full p l a y t o t he sp i r i t of c o m p e t i t i o n . * * *

Whe the r t h a t s y s t e m of d e a l i n g wi th r a i l r o a d c o r p o r a t i o n s will s u c c e e d or no t c a n b e a s c e r t a i n e d b y v i e w i n g the i r h i s t o r y in t h e S t a t e of N e w Y o r k , a n d t he e x p e r i e n c e which w a s h a d in t h i s S t a t e , d e m o n s t r a t e d t h a t it d i d no t w o r k t o t he a d v a n t a g e of t he p u b l i c a n d t h a t t h e ev i l s connec t ed wi th t he s y s t e m were s i m p l y e n o r m o u s , a n d u n e n d u r a b l e . C o m p e t i t i o n cou ld no t e x i s t u p o n r a i l r o a d s . *

Some years ago the state of Massachusetts appointed a Committee of Gas and Electricity, empowered to inquire into and revise rates charged, operating costs, capitalization, and to limit competition. Although this commission was looked upon as something of an experiment, the high quality of work accomplished by it has commanded the respect and approval not only

* F . W . S t e v e n s a d d r e s s , Α . I . Ε . E . dinner , 1 9 0 8 ,


of the public at large, but also of the corporations themselves, who, through its protection have been guarded against unfair and unnecessary competition.

Encouraged by the good work accomplished through this commission, and other commissions having to do with railroads, etc., and supported by those who were opposed to municipal ownership but believed that the conduct of corporations should be regulated and controlled, there has developed within the last year or two a popular demand for other state commissions with large powers that could compel, particularly railroads and gas and electric corporations, to comply with their obligations and furnish reasonable service at fair prices. Without attempting to discuss whether regulation should properly be undertaken by the state or federal government, it would appear that if intelligent regulation of such corporations as railroads is to be obtained, it must be done at least in part by the nation rather than through each state attempting to pass its own laws, perhaps contradictory to those of an adjoining state in which the same railroad must operate. On the other hand, state or even municipal control of gas and electric corporations might seem both logical and legitimate, provided the personnel of the board of control is capable honest and unprejudiced. In fact, the corporations themselves, as a rule, welcome such regulation, as it will protect their properties from hostile and wasteful at tacks, vicious competition, and unfair manipulation of its securities. Their objections are almost always based on either a fear of corrupt or dread of well-meaning, incompetent, and inexperienced men, as commissioners, or else that questions under consideration would be decided from the standpoint of the past rather than the present. For example, it would, of course, be unfair, to take advantage of the present investment of a corporation, of which the stockholders cannot unburden themselves, to make an unduly low price for its commodity. In each case the rate of return allowed a going corporation should be the same as that to a new corporation rendering the same service.

New York started in a mild way with several commissions for different purposes; but last year, under the leadership of Governor Hughes, the state passed laws substituting for the other commissions, two state commissions, one to have charge of all public utility corporations in Greater New York, and the other in the remainder of the state. To these two commissions were delegated almost unlimited authority, they having power

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to examine corporation affairs as completely as any board of directors, and to require changes in methods of operation and even reduction in prices charged for service.

Other states are following the precedent established by Massachusetts and New York. Wisconsin already has such a commission appointed under an act of the legislature, which is well worth perusal by any one desirous of learning the present-day radical trend of opinion. There is little doubt but that before long, nolens volens, most or all the states in the union will have commissions appointed to control and regulate at least the so-called public utility corporations. That such commissions have the right and power to determine rates, has been established in New York state by the courts, in the Saratoga case.

How, then, are these commissions to deal with the corporations in protecting the public, and at the same time give the investor every encouragement for profit, and the business no lack of opportunity ? In this connection it is important that the engineer inform himself jus t what is the difference between operation, regulation, and confiscation.

With regard to operation, public utility commissions should restrict their action to general principles ; they should not interfere with details, otherwise they will remove the present responsibilities from the shoulders of the directors to their own shoulders, restrict and hamper the efficiency of the organizations, still the incentive to work, and destroy the reasons for promotion of the employees—all of which will result in depreciating the service rendered the public and the financial standing of the corporations themselves. As has been well said :

R e g u l a t i o n s h o u l d s t o p where o p e r a t i o n b e g i n s . M a t t e r s of b u s i n e s s d i s c r e t i on s h o u l d b e left t o t he dec i s ion of t h o s e w h o a r e r e s p o n s i b l e for b u s i n e s s r e s u l t s . *

If state regulation is to determine rates and limit the earnings upon investment, it may logically be asked, should the state not also include a guarantee of reasonable returns on the investment? If a corporation takes all the risks, it is logically entitled to all the profits. If the state prohibits anything more than a definite profit, may it not be morally bound to assure that profit? In fact, municipalities have been known to go a long way in this very direction by granting an exclusive franchir e, which affords a monopoly and prevents competition.

* R e p o r t , C o m m i t t e e P u b l i c Pol icy , N . E . L . Α., 1 9 0 7 . ~

FLOY: THE ENGINEER'S ACTIVITY [Apr i l 10

The principle of state control is not new, although its application has recently been greatly broadened. We have become so accustomed to considering liberty as unrestricted license for all, that the statement of Chairman Stevens of the New York State Commission, at the dinner of the American Institute of Electrical Engineers in February, that the public can demand and take from the individual, much less the corporation, anything " from his pocket book to his life inclusive " , was as startling as true. The only precedent to the taking, is the public necessity and the proper manner and remuneration. In theory, then, regulation is correct, if only the practical application to the concrete case were not so difficult.

Confiscation means the taking of property without allowing " fair return " thereon. Fair return is a smooth legal term which neither the courts nor anyone else has yet been able precisely to interpret. In the decision of the United States Circuit Court in the Columbus case, an unallowed demand for a reduction in electrical rates, a decision with which every engineer interested in public utilities should be acquainted, it was stated that, over and above legitimate operating expenses and depreciation charges ;

T h e owner of t he p r o p e r t y shou ld b e a t l e a s t p e r m i t t e d t o r ece ive a s his c o m p e n s a t i o n for i t s u s e t he l e g a l a m o u n t of in te res t a l l o w e d b y the s t a t e of Ohio .

The court then goes on to say : I t m a y well b e d o u b t e d whe the r t he l e g a l r a t e of in te res t is r e a s o n a b l e

a n d j u s t c o m p e n s a t i o n t o t h e owner of t h e p r o p e r t y d e v o t e d t o p u b l i c u se , e t c . * * * I t m a y well b e d o u b t e d whe the r c a p i t a l w o u l d a t a n y t i m e for th i s l e g a l r a t e a l o n e b e wi l l ing t o en te r u p o n t he r end i t i on of p u b l i c s e rv i ce of t he k i n d p e r f o r m e d b y t h e c o m p l a i n a n t u n d e r t h e s e c i r c u m s t a n c e s a n d condi t ions . , e t c .

Again in the famous case against the Consolidated Gas Company of New York, in wdiich a reduction was sought from $1.00 to $0.80 per thousand feet of gas . The court has held that the owner is entitled to " a fair return upon the reasonable value of his property ", which is guaranteed to him by the famous fourteenth amendment to the Constitution.

Apparently, the existing state commissions realize the importance of a comprehensive, thoroughly considered, and reasonable line of action based on " well settled principles of public policy " ; and they feel the necessity of proceeding cautiously in order to establish correct rulings and avoid the charge of confiscation.


But the radical feeling of the time, as well as some unexpected conclusions, are indicated by certain rulings of the several state commissions with regard to public utility corporations. These are worth considering as illustrating general conditions which the engineer must bear in mind when advising his client as to investments and earnings.

The commission of the second district of New York states that they have :

R e f u s e d t o cons ide r t h e a p p l i c a t i o n of fore ign (o ther t h a n t h o s e inc o r p o r a t e d u n d e r t h e l a w s of t h e s t a t e of N e w Y o r k ) g a s a n d e lec t r ica l c o r p o r a t i o n s t o d o b u s i n e s s in t h i s s t a t e , a n d h a v e a n n o u n c e d i t a s a ru le t h a t n o a p p l i c a t i o n will b e e n t e r t a i n e d .

The Wisconsin statutes provide that only corporations organized under the laws of that state shall receive franchises therein. I t seems to me that this is a somewhat narrow policy which can not be long continued without modification.

The same New York State Commission has decided to accept as satisfactory, unsealed electric meters having not more than 4 per cent, of error, although requiring gas meters to be within 2 per cent, of correct, and sealed by a representative of the commission. It is doubtful whether the leniency of the commission toward electrical operating companies will compensate the manufacturing concerns for the odious comparison made of the electric meter with the much slandered gas meter.

The same commission announces unequivocally that it will require each corporation to maintain a depreciation fund which must be provided out of earnings. This is a very wise conclusion required by the statutes of some states, and a step which many corporations have failed to take, as they should have done for the protection of their security holders.

In the Lockport decision the New York State Commission established an important precedent; they allowed the consolidation of two competing companies, but prohibited, as prescribed by statute, the issuing of securities to an amount exceeding the total capitalization of the two old companies. They also prohibited any increase in the price of gas and electricity over the prices made by the respective companies during competition. Thus it appears, losses resulting from a war of extermination and the increased cost of consolidation cannot be met by the issuance of new securities, as formerly, which is from one standpoint radical and far-reaching. Again, the commission ruled that the low prices reached through competition should not be raised

362 FLOY, THE ENGINEER'S ACTIVITY [Apr i l 10

after consolidation, which, while protecting the public, possibly might tend towards bankruptcy for some consolidated companies.

As the result of its experience, the Massachusetts Gas and Electric Light Commission has recently reported that it finds the benefits of the consolidation of gas and electric companies in cities of considerable size do not compensate for the disadvantages to the public arising from such consolidations.

The engineer, of course, well knows that it costs more per unit to deliver gas or electricity to the small consumer than to the large consumer, yet the New York Commission of Gas and Electricity that went out of existence last Ju ly fixed a maximum kilowatt-hour charge to be made by the Rockland Light and Power Company in Orangetown. I t has been shown that out of 112 customers served at a loss under the rate formerly charged, 75 would receive service under the new rate at a greater loss to the company; while out of 26 served at a profit, 19 must be served at an increased profit to the company in order to make good the losses increased by reduction of price to the 75 mentioned above. I t is hardly necessary to say that the courts would not sustain this ruling, as was proved in the well-known Columbus case. The present commission has, by petition, taken under consideration an order to restore the old rates.

A consideration of the rulings of state commissions shows a tendency to place all corporations on the same footing as regards the returns to investors; that is , regardless of whether capital has been invested in a judicious and intelligent manner or in an inefficient way, the precedents established indicate that about the same profit will be allowed in either case. This, of course, does away with all incentive to improve the earnings by cutting down operating expenses, or to decrease the price, or introduce new apparatus or modern methods. I t removes the stimulus heretofore existing with the individual, to make the very best showing possible, and hence is a reasonable, valid, and practical objection to control by commissions. One method of offsetting this very decided disadvantage has been evolved by the application of the London sliding scale, so-called because originating in London, England, and now in use in Boston. The principle is a profit-sharing one, in which the investors are entitled to a definite rate on their investment with a fixed price for their product to the consumer. Every decrease in price, as for example 5 cents per unit in the case of gas at Boston, entitles the investors to an increase of one per cent, in their rate of dividend. An


objection to this plan is that while it may be perfectly fair for a term of years, improvements in methods of manufacturing may so largely reduce the manufacturing costs as to entitle the investors to abnormally large dividends, at which time a readjustment of the base for price of product and rate of dividend would result in seriously depreciating the securities held by the owner at the time of such adjustment. This London scale, however, is at present the best practical method evolved for automatically adjusting profits as between the public and the corporation.

Franchise valuations. In considering the expenses and profits of a public-service plant, the engineer must determine the proportion of earnings to be applied to taxes and dividends, the amount of both of which will usually be affected by the value of the company's franchise. At present the franchises of different corporations are variously valued at from less than nothing, or a liability, up to a $ 2 0 , 0 0 0 , 0 0 0 asset. Therefore, the competent public corporation engineer must understand what a franchise is, its dollars and cents value and its distinction from the goodwill of a going organization, favorable contracts, or physical property.

A franchise is a license, granted by a state or municipality, recognizing the right of a public utility corporation to do certain business along prescribed lines. As the privileges and earning power of franchises vary, so their values vary. On one extreme it has been argued that because a franchise costs nothing, or is supposed to cost nothing, it should not be valued or capitalized by a corporation—the present New York statutes prohibit capitalization of franchises by new corporations—because then the public is forced to pay, by increased cost of service, the fixed charges on what they have themselves once owned and gratuitously bestowed. The corporation replies that its franchise is regularly and heavily taxed. If it has no value, it cannot fairly or logically be a subject for taxation; if it has value, it can and should be capitalized. The answer made to this is that the franchise tax is included among the items which go to make up the proper selling price of the corporation's product, and therefore is indirectly paid by the customer without in any way affecting the stockholders' investment or profit.

On the other hand, as the engineer well knows, franchises are frequently granted as a sort of bonus to induce capital to undertake, perhaps at a loss at the start, certain operations for the


benefit of itself and the public. One purpose in accepting such obligations has been, not immediate return, but the profits to be gained in the future by the growth of the town or state and the consequent increase in revenue. As time goes on, the value of the franchise increases the same as real estate, or a desirable business location, and it would seem might be just as logically recognized as of value and capitalized.

Granted that certain franchises have become enormously valuable, corporations should not be disparaged on that account. If the public gave away something for nothing, they did so because they were unable to secure any price for it, or they failed to recognize its value and made a poor bargain, or their officers betrayed their trust. Under any of these suppositions the corporations may stand blameless, and are perfectly entitled to their franchises and the value of them. It is but a few years since it was impossible to interest capital in the construction of the New York City Subway; finally, privileges were offered as an inducement and the construction completed, which' has proved a notable financial success. Should any one now claim that because the investors have profited largely the contract should be annulled? Yet a few weeks ago the startling doctrine was advanced by a public service commissioner that we of to-day are not bound by an agreement of yesterday, that:

A c o m m o n counci l or a l eg i s l a tu re m a y b a r t e r a w a y a n y p r e sen t r igh t s , y o u r s or m i n e , for t o - d a y . B u t t h e fu ture is no t the i r s t o g i v e . T h e y m a y no t d i s p o s e of r i gh t s which b e l o n g t o our ch i ldren a s m u c h a s t o us , a n d t o thei r ch i ldren a n d the i r ch i ld ren ' s ch i ldren a f te r t h e m . T h e y m a y a l low p r i v a t e d e v e l o p m e n t a n d m a n a g e m e n t for the s a k e of i m m e d i a t e p u b l i c a d v a n t a g e , a n y s u c h i n v e s t m e n t m u s t b e s c r u p u l o u s l y p r o t e c t e d ; b u t t he f ranchise i tself is s o m e t h i n g which m a y no t b e g i v e n a w a y b e c a u s e it is no t wi th in the p r o v i n c e of the L e g i s l a t u r e to g i v e a w a y t h a t which d o e s no t b e l o n g t o t he e x i s t i n g c o m m u n i t y .

A f ranchise g r a n t e d b y the l eg i s l a tu re of fifty y e a r s a g o b e l o n g e d then t o u s of t o - d a y q u i t e a s m u c h , if no t m o r e , t h a n t o our g r a n d f a t h e r s , w h o h a n d e d it ove r t o s o m e r a i l r o a d in p e r p e t u i t y . I t b e l o n g s t o u s now, a s it will b e l o n g t o our g r a n d c h i l d r e n in the i r tu rn . T h e a c t i o n of the leg is l a t u r e of t w o g e n e r a t i o n s a g o in g i v i n g a w a y our b i r th r igh t is no t m o r a l l y a b i n d i n g c o n t r a c t u p o n u s t o - d a y when it c o m e s in conflict w i th p r e sen t or fu ture p u b l i c in te res t s , a n d the v e s t e d r igh t s of t he p r i v a t e inher i tors of t h a t f ranchise will no t s t a n d when t h e y c o m e in conflict w i th t he v e s t e d r i gh t s of t he whole p e o p l e of t he S t a t e of N e w Y o r k .

T h i s m a y no t b e ' g o o d l a w ' now, b u t I be l i eve it will b e in a v e r y shor t t ime , for t he p u b l i c p e r c e p t i o n h a s g r o w n v e r y swif t ly of l a t e . A n d t h e c o u r t s of l a w a r e neve r v e r y far b e h i n d p u b l i c op in ion . S o m e legal way will always be found sooner or later to do what is morally right.

1908] 1 FLOY: THE ENGINEER'S ACTIVITY 365

If the commissioner is correct the engineer must know it, and figure a large annual depreciation on the value of franchises ; he must ask when does the last generation's rights end and today 's begin; on what day after granting does the legislature's perpetual grant cease, is it to-morrow or day-after-to-morrow, or next week, or when? Doubtless the commissioner is influenced by the trend of both public opinion and some recent cou it decisions emphasizing the right of public necessity as against individual or corporate welfare. Perhaps he is overwrought by intimate contact with the oppression resulting from certain grants ; but, however rapidly we may have grown in socialistic doctrine, the engineer cannot agree that obligations can be broken simply because they are onerous. He recognizes that the franchise granted 50 years ago had neither the opportunities nor responsibilities of that same franchise to-day. New conditions beget new obligations, which the corporation must meet or the franchise may become valueless on its hands.

Aside from feeling or argument in the matter, the courts have held, and will doubtless always hold, unless it is expressly excepted, that a franchise is property and a more or less valuable asset. If, then, the franchise is property, what may be the value of the property? The present secretive, uncertain, inequitable, unscientific method of arriving at the value of each corporation's franchise, as practised by the State of New York, for example, is, to use the language of the courts themselves, " little more than a guess " and should be replaced by something simple, logical, uniform, and publicly determinable.

It may be right to prohibit the capitalization of future franchises beyond what they have legitimately cost, but the engineer interested in seeing a " square deal " should oppose any at tempt to destroy by flat legislation the value of franchises already established. In many cases there can be no objection to letting the corporations evaluate their own franchises, because the necessity of offering their product at a reasonable selling price on one hand, and, on the other hand, meeting the taxes that may be imposed by the public, will, in the end, generally establish a fair value for a given franchise. Where state commissions have been appointed with large powers to control and regulate public utility corporations, it will be necessary for them to, determine a value for the franchises of the various companies, under their supervision. Thus far, no logical or uniform method of evaluating franchises has been determined upon by tax


assessors, the corporations themseh res, the public utility commissions, or the courts.

The more common method of evaluating a franchise that has prevailed, especially among those interested in owning and selling corporation securities; namely, considering the franchise as worth the difference between the value of the physical property of a corporation, and the market value of its stock and bonds, can hardly be considered tenable, for the following reasons:

1. Because in such valuations is included not only the franchise value but also the worth of good-will, favorable contracts, business organization, etc.

2. Because the daily fluctuating price of stock and bonds due to general business conditions, market manipulations, or stock jobbery, make it, as a practical matter, extremely difficult to determine the fair market value of a corporation's outstanding stock and bonds.

3. Because the market value, even if correctly determined, does not indicate, in many cases, the real value of a corporation's stock and bonds. The market value of said securities often depends upon the success with which printer's ink and promoters' efforts have succeeded in impressing the mind of the public, which is generally ignorant, intentionally or carelessly, of actual operating and financial conditions.

The wide difference of opinion among the courts, and the general uncertainty as to the proper method of setting about fixing franchise valuations, is illustrated by the contradictory conclusions reached by the two different officers of the courts who have attempted to place a value on the franchises of the gas companies operating in New York City. The Master who conducted an exhaustive hearing in the matter decided that the franchises were worth $20,000,000. Judge Hough, of the United States Circuit Court, who reviewed the Master's report, concluded that the same franchises were worth $12,000,000. Certainly there should be some fair method evolved for more closely approximating the real value of a given franchise than the wide divergence indicated by these figures. The rule of law under which this country operates is not based on an opinion, guess, or the discretionary rule of an individual, even though clothed with governmental authority. The action of courts, assessors, or commissioners, must be restricted as far as possible to forming conclusions based on definite and fixed laws. I t would seem as if the engineering profession, as a disinterested party,


appreciating the necessity for and relation of a franchise to a corporation's business, might assist in evolving some method of fairly and logically fixing franchise valuations. The following is suggested with that thought in mind.

Starting with the premise that on one hand the investor in electric and gas utility securities has been demanding a return of from 9 per cent, to 15 per cent, on the actual investment, as shown by the testimony in the Consolidated Gas case from such witnesses as Messrs. Emerson McMillin, N. W. Halsey, Samuel R. Bertron, Allan B . Forbes, " bankers having much experience with gas properties in their investments ", and on the other hand that the courts, as indicated for example in the Consolidated Gas case and the Columbus decision, are inclined to base their decision of " fair return " upon the investment, upon the legal rate, which varies from 5 per cent, to 8 per cent, in different states, we have the extremes of earnings considered fair; namely, from 5 per cent, to 15 per cent, on the actual investment, depending upon location.

For purposes of discussion herein, consider a corporation operating in the state of New York, where the legal rate which, at least, will be allowed by the courts as a "fair return" is 6 per cent. In view of the fact that the capitalist has indicated that he will not be interested at 6 per cent., but that perhaps 9 per cent, would be attractive, are we not safe in assuming that with a New York corporation he would be content with 8 per cent, when he knows that his property will be defended from unfair taxes and competition through protection afforded by a state commission? The nature of the business, compared with other enterprises, is such that the return of 8 per cent, upon the investment actually made by a public utility corporation would not seem unreasonable. Now if the capitalist will accept 8 per cent., and the court will stand by the legal rate of 6 per cent., we have only to prove that the value of the franchise—which the courts have uniformly admitted should be considered as of value—is worth one-third the amount of the actual investment to secure an allowance of 6 per cent, on the whole, or 8 per cent, on the actual cash investment.

An examination of the values placed on many franchises in the past for purposes of taxation, capitalization, condemnation, or court decision, will indicate that perhaps an average valuation of the franchise in each case is not far from one-third of the actual replacement value of the corporations assets. This ratio, though

3 6 8 FLOY: THE ENGINEER'S ACTIVITY [Apri l 10

somewhat arbitrarily assumed, would seem under present circumstances to be both a fair and reasonable one for existing franchises. If it is a middle ground on which the various conflicting interests could meet, we will have an automatic, easily determinable, open and above-board method of evaluating franchises. As will be recognized, the proposed method gives a different value to the franchises of different companies, but is equally fair to all because based on their tangible value : it will also be seen that the value of the franchise of a given company may vary from year to year, depending upon the value of their property. Both of these variables are essential in a franchise valuation.

E x a m p l e i l lustrating " fair return " for New Y o r k corporat ion.

Life of franchise 20 years Perpetual

Cash investment or replacement value $300,000 $600,000

Capital izat ion of franchise a t 33% 100,000 200,000

Tota l capital ization $400,000 $800,000

All operat ing expenses , 40%-50% gross 36,000 96,000

Maintenance and repairs, 7% on 66% inves tment 14,000 28,000

Depreciat ion fund, 5% on 66% investment 10,000 20,000

Amort izat ion on franchise va lue , 5%i 5,000

Interest on total capi tal izat ion, 6%; 24,000 48,000

Gross income $89,000 $192,000

In making up the annual operating and fixed charges of a corporation, it is proposed that the state commission should consider the value of the franchise, as determined above, allowing the legal rate thereon and also a further amount for depreciation or amortization, depending upon the life of the franchise. This latter figure, in the case of a perpetual-franchise, would be nothing; but in the case of a short-time franchise would be a very appreciable amount, which of course must be paid by the public. The economy of a perpetual franchise, which the com-panies desire, will be appreciated, and there is no great objection to it, provided its owner is properly restricted so as to safeguard the public interest. To illustrate the foregoing, let us consider a concrete example of a New York corporation which has been granted a liberal franchise for a period of twenty years,


and has invested $300,000 in order to establish a going business, compared with a similar corporation having a perpetual franchise and an investment of $600,000 For more fully illustrating conditions as found, we will assume that the general operating expenses, in the first case are 40 per cent, of the gross income, and in the second case, 50 per cent, due to differences in apparatus installed and efficiency of management. Repairs and maintenance will be taken at 7 per cent, and depreciation at 5 per cent.

If the gross income exceeded the above figures, the price of the corporation's product should be reduced proportionately to a prearranged increase in dividends, in accordance with the London scale or a modification thereof. If the gross income were less than the above, it would be proper to increase the price of the commodity, as was authorized, for example, by the Wisconsin Public Utilities Commission in the case of the LaCrosse Gas and Electric Company.

I t will be noticed from the abo\^e example, that in a different state with a different legal rate the returns allowed on the investment, and consequently the gross income allowed, would be different. This is as it should be, because the rate of return varies in different parts of the country, as is recognized by the various legal rates in the different states.

The plan suggested for regulating corporations does not place all the corporations on exactly the same basis at the start, as indicated by the example given, due to difference in efficiency of apparatus or management ; but these differences are probably not greater than those which arise by reason of location, business opportunity, or public sentiment, and will doubtless about offset one another independently of the fact that the effect of the London scale properly applied has a tendency to bring all companies to the same earning basis.

If some definite plan for determining " fair return " in connection with franchise valuation, could be agreed upon and urged by any considerable proportion of. disinterested people conversant with the facts, or even the corporations themselves, would not the commissions and the courts be inclined to accept and adopt such precedent thus established? The result would be a definite knowledge of what returns from public utility corporation investments could be counted upon, and what valuations would be accorded their tangible and intangible property, ignorance of which facts is the principal reason for the present unsettling of their business, undervaluating of their securities, and to some extent the discrediting of the work of the engineer.

The engineer's activity in public affairs — Public utility commissions and franchise valuations

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