that there has actually been a decline in the relative expenses of operation during the last few years? On the contrary, statistics show that operating expenses have been increasing much more rapidly than net income. In 1899 the proportion of operating expenses to gross income from operation was 65.24 per cent, while in 1904 it was 67.79 per cent. At the same time the proportion of net income from operation to gross income fell from 34.76 per cent to 32.21 per cent.1 If we let A and A' represent the proportion to gross income of operating expenses for the years 1899 and 1904 respectively, and B and B' the proportion of net income to gross income for the same years, we have: 1.875 2.146. Thus in the relation of the two items operating expenses have gained about 14 per cent on the net income. 2 A A' : B :: In 1899 the average cost of running one train one mile was $.98, while in 1904 it had risen to $1.31, showing an increase of 33.7 per cent. In 1899 the gross receipts per train-mile were $1.50, while in 1904 they were $1.94, an increase of 29.2 per cent as compared with an increase of nearly 34 per cent in the cost of operation. At the same time the increase in net revenue per train-mile was only 12 cents, or 23.1 per cent. Thus the percentage increase in net revenue per train-mile was nearly one third less than the increase in operating expenses. Nevertheless, net revenues of the railroads have been considerably augmented within the last few years. As we have already shown, this has come as a result of the 1 These statistics are not conclusive owing to our inability to estimate accurately the amount which has been spent in permanent improvements and charged to operating expenses. The statistics for 1905, which have just been published, show a slight decrease in the proportion of operating expenses. ? The operating expenses as here used include the cost of maintenance, but no part of the fixed charges. (See Statistics of Railways of the United States for 1899 and 1904.) general prosperity of the country, and of the great increase in the amount of business rather than from the slight advance of rates which has occurred. Every indication tends to confirm the belief that the present boom period is of a temporary character, and railroads are justly entitled to share in the general prosperity along with other industries in order that they may indemnify themselves for losses sustained in periods of depression. In consideration of the point as to the reasonableness of American rates but one other possible standard remains to be considered. That is the relation of income to capital investment in railways. Do the railroads of the United States pay more than a fair return upon the amounts actually expended in their construction and improvement? Every one would readily admit that the individual who risks his capital in a railway enterprise, which is always more or less precarious, is entitled to a just compensation for the interest on his investment, and for the risk which he assumes; for if investors were to be deprived of the privilege of earning such returns, there would never be another mile of railway built in this country, which in the present state of our economic development would be disastrous. It is necessary, therefore, that we should examine the returns upon railway capital in order that we may determine whether or not more than a reasonable rate of interest has been paid upon such investment. If it can be shown that railway capital is not paying more than a reasonable return, we must conclude that the public is not justified in taking steps which will result in a material reduction in the returns upon that capital. In order to obtain any accurate data by which to judge of the reasonableness of the returns upon railway capital, it is necessary to ascertain as nearly as possible the basis of the capitalization of the various railroads. Unfortunately the early dealings of most of our railroads are so shrouded in obscurity that accurate data for this purpose are not obtainable. Even estimates of the relation of the present railway capitalization to the amount of capital actually invested are but little better than guesses. Nevertheless the general impression of the public is that American railroads are grossly overcapitalized, and that dividends apparently low are in fact enormous when compared with the amount of capital actually invested. It is true that this might have been the case at one time, if dividends had been paid at all, but the fact is that scarcely any of these overcapitalized roads paid any dividends whatever during the first decade or so of their existence. In the mean time a great deal of water was squeezed out of their capitalization, occasionally by reorganization, but more often by the gradual enhancement in the value of their tangible assets, by the advance in the prices of labor and materials, by the enormous increase in the value of the rights of way and terminal property, and by the gradual investment of earnings in permanent improvements. Therefore it cannot be doubted that the amount of water in the capitalization of American railways has been greatly reduced if not entirely eliminated. It is generally admitted that there is little water in the capitalization of European railways. Yet the average capitalization of the railways of Europe is $127,696 per mile, while that of the American railroads is but $61,396. It must be borne in mind, however, that the railroads of England, and of some of the countries of Southwestern Europe, are in general much better constructed than those of America. The above average, however, includes the railways of the Scandinavian Peninsula and those of Russia, which are on the whole more poorly constructed than those of the United States. Then, too, as we have already noted, the labor used in the construction of American railways was nearly three times as expensive, and the price of many of the materials used was higher, though the cost of the rights of way was much less. It is impossible to ascertain to just what extent, if at all, American railroads are overcapitalized to-day. Certain facts, however, must be borne in mind. In the early days of railway history, overcapitalization was absolutely necessary. The investor believed that the stock of a successful enterprise ought to go to par, and the difference between the amount paid for the stock and its par value represented to him what he considered to be a fair remuneration for the risk which he assumed. It would have been next to an impossibility to have induced the investors to pay the face value for a smaller amount of stock; for whatever may be the capitalization of a company, it is always easier to persuade the investor to take a large amount of stock at a low figure than it would be to induce him to take a smaller amount of stock at a higher price. In the more settled conditions of railway finance which prevail to-day the incentive to permanently maintain a state of inflated capitalization is not as great as it was in the early days of railroad history. For the past twenty years, therefore, most of our great railroad systems have been making large expenditures for permanent improvements and paying for them out of current revenue instead of charging them to capital account. There is another fact which makes railway capitalization appear larger than it really is. The misapprehension arises from the fact that in the statistics showing the total capitalization of the railways of this country and the capitalization per mile of line, a considerable portion of railway capital is counted twice. Wherever one railroad owns a part of the stock or bonds in another, it usually increases its own capitalization sufficiently to cover this new asset. The stock which is so owned is thus represented in the capitalization of both companies. The dividends upon the stock thus held by another company are amalgamated into its general revenue, and are eventually again paid out in dividends upon its capital. Thus the total amount of money paid out in dividends is in reality much smaller than it appears from the statistics. The amount of railway stocks and bonds owned by other railroads was, in 1904, $2,501,330,601,1 or more than twenty per cent of the total railway capitalization. If this vast amount of stock were canceled, as it might properly be, in the statistics showing the total outstanding capital account of the railways, the actual capitalization per mile of line would be found to be nearer $45,000 than $60,000. In order to make this point perfectly plain, let us assume a specific case. Let A and B represent two railroads of 2000 miles of line and a capitalization of $100,000,000 each. If A desires to purchase one half of the capital stock of B, it would probably issue a sufficient amount of its own stock or bonds to cover the necessary outlay. It would thus increase its own outstanding capital account by $50,000,000, but it would hold in its treasury $50,000,000 of the stock of B as the asset upon which the increase was made. The outstanding capital account of the two railways would then be as follows: Capital stock and bonds of A outstanding, 66 Amount of capital stock of B in treasury of A, $150,000,000 100,000,000 50,000,000 250,000,000 Thus after this transaction we find that the total capitalization of the two roads has been increased by $50,000,000, while the average capitalization per mile of line has been increased from $50,000 to $62,500. In a transaction such as this there is no stock-watering whatever. The increase in capitalization is only nominal. Obviously the actual amount of securities upon which dividends must be paid from the earnings from operation has not been increased or decreased. The same amount of net revenue will 1 In 1905 the total amount of railway stocks and bonds owned by other railways was $2,638,152,129, representing an increase of 5.5 per cent over 1904. |