Roads grouped according to stock ownership, 3-year averages-Continued.

Roads controlled by construction and industrial companies, 3-year averages.

EXHIBIT C.

Roads recently or at present in hands of receiver, 3-year averages.

One-half of stock owned by Denver & Rio Grande. 4 Formerly New Orleans, Mobile & Chicago.

Includes Brownwood North & South and Paris & Great Northern.

1 Reorganization of San Pedro, Los Angeles & Salt Lake. Oregon Short Line owns one-half of stock.

Before proceeding with my criticism of the statistical exhibit of the railroads, I should like to clear up one point. It is commonly stated and quite generally believed that there is no relation between net operating income and property investment or capital obligations. Theoretically this is true. But in the actual operation of a railroad the expenses of operation in general are affected by the fact that there must be at least a certain net operating income at the end of the year with which to meet charges of the property investment account and capital obligations. In a real practical sense the practice of a road year by year comes to be such in regard to a net operating income as is determined by the knowledge that certain property investment and capital charges of the corporation are to be met out of that income.

Briefly, the operating income of the railroads in these exhibits are the result of the fact that there do exist in these roads certain property investment and certain capital obligations. That is very strikingly illusrated in the 1914 Rate case. When that case was first started by the railroads, the prospects were for very low earnings for that year, and they started the case before the commission when there was a relative business depression. Before the case came to trial industrial prosperity came and the earnings of the railroads jumped by leaps and bounds. If they had gone before the Interstate Commerce Commission with the same operating and maintenance expenses that they had previously had, they would have shown before that commission in that advance rate case the highest net operating income in their history. The way they did present the statistical result was by spending it on maintenance of equipment and way and structures-in other words, the maintenance of equipment and way and structures were larger than any year in the history of these railroads and statistical charts were prepared showing the tendency of those two accounts toward a remarkable jump in that one year. Otherwise the net operating income of the roads would have been so large that, as a practical problem, there would not have been much chance for the Interstate Commerce Commission to increase rates.

In general, the property-investment account of the railroads is the same as that of road and equipment of the Interstate Commerce Commission. In the reports of the carriers to this Federal body it is required of them that this account shall include the accounting company's investment in road and equipment, including that held under contract for purchase, in existence at the date of the balance sheet. This requirement was first made of the railroads in 1907 and the reports to the commission usually show the accumulation of such investments up to that time and subsequently. It is important, however, to recognize the fact that up to June 30, 1907, the great majority of the American railroads did not base their investment in road and equipment on cost.

Mr. William E. Hooper, associate editor of the Railway Age, in his book "Railroad Accounting" (p. 235), says:

The figures that were given were in most instances derived figures. A group of men decided to build a railroad. They got together certain franchises, options on right of way, etc. They then issued a certain amount of stock with a nominal par value and borrowed money, issuing bonds secured by a mortgage or some other form of indenture on the property, which they turned over to the

company. When the books of the company were opened the property which was turned over to it was entered on the debit side of the balance sheet as the first asset, not at what it cost anybody in money, but at a figure expressed in dollars and cents, which corresponded with the nominal par value and face value of the total securities issued.

In consequence of this method of constructing a balance sheet that was in common use by the American railroads up to 1907, the figures reported by the roads to the commission as property investment necessarily contain errors of great importance.

It is with no desire to muckrake or to criticize the railroads that we call attention to these errors. Reference will not be made to all of them in detail, but only a sufficient number of illustrations have been selected to indicate to you the character of the property investment account which has been submitted to this committee as a basis for measuring the return to the railroads during governmental operation.

The cost of construction as given by the books of the Baltimore & Ohio Railroad is not probably of much significance, says the Interstate Commerce Commission in its report on the Advance Rate case of 1910:

The system is made up of a great number of smaller properties constructed as independent lines. According to our understanding, the cost of construction, as shown by the books of the Baltimore & Ohio, is simply an aggregate of that shown by the books of these subsidiary companies and under the circumstances could hardly represent the actual fact.

In 1899 the Baltimore & Ohio was reorganized and taken out of the hands of the receivers.

There is nothing before us

Says the commission

to show the terms of the reorganization. There was no foreclosure sale, and whatever was done in the way of changing or scaling securities was by agreement. It does not appear what the $152,000,000 of common stock actually represents nor what it cost the owners of that stock by the terms of the reorganization. The capital account materially exceeds the cost of production, as shown by the books of the company, and the per mile capitalization strikes us as rather high.

The Cincinnati, Hamilton & Dayton, located in a territory of constantly growing traffic, was mismanaged by financiers and was exploited by them for speculative purposes during several years prior to 1905, when it was placed in the hands of receivers.

The commission further says:

The receivership was not closed until in 1909, when the Baltimore & Ohio Railroad Co. was induced to assume control of the Cincinnati, Hamilton & Dayton. This involved advances by it in cash aggregating approximately $22,000,000 to meet the maturing notes and current needs of the Cincinnati, Hamilton & Dayton; it also involved the guaranty by the Baltimore & Ohio of a large part of the inflated securities of that company. The sums so advanced have been carried in the accounts of the Baltimore & Ohio as assets, and, until the fiscal year 1913, the interest due on the advances was credited to the income account of the Baltimore & Ohio. The consequences to its income and surplus from this unfortunate alliance were therefore not shown in the annual reports of the Baltimore & Ohio to its stockholders or in its reports to this commission. Nor do they appear in the statistics offered by the Baltimre & Ohio in this proceeding (referring to the 1914 Advance Rate case) to show its need of greater revenues. The burden proved, however, to be so great that the management of the Baltimore & Ohio recently determined to withdraw its aid, and the Cincinnati, Hamilton & Dayton has again passed into the hands of receivers. The income account of the Baltimore & Ohio for 1914 will begin to show this drain.

The Interstate Commerce Commission, although unable to secure complete information of the financial affairs of the Louisville & Nashville, nevertheless feels itself justified by the facts of which it does have knowledge to state officially that the cost of road account of this company "is heavily burdened with charges which do not represent actual construction cost."

From incomplete information it is concluded that "at least $16,000,000 shown in the cost of road account covers items which should not be charged as a part of the costs of this carrier's road." A stock dividend of 100 per cent was declared by the Louisville & Nashville on October 6, 1880. According to a corporate history of this railroad, which was found in its office, 10 stock dividends were declared by this company between 1860 and 1891. To make possible the stock dividend of 100 per cent referred to, the amount of surplus was arbitrarily increased by raising the book value of certain assets. The commission states that permanent improvements on the Louisville & Nashville have, in the past, to a large extent, been made out of earnings and subsequently charged to the capital account. (Interstate Commerce Commission in its report on the financial relations of the Louisville & Nashville Railroad Co., p. 170.)

It seems appropriate at this point to call attention to certain facts incident to the issuance of capital stock and the acquisition of property by the Nashville, Chattanooga & St. Louis, a subsidiary of the Louisville & Nashville. The issued capital stock of this carrier, says the commission, amounts to $16,000,000, par value, of which $15,984,787.50, par value, is outstanding. It appears that cash aggregating only about $9,831,840.77 was received for this stock, while an amount exceeding $8,107,398.50 was given to stockholders in the form of stock dividends, and by the sale of stock at prices below par, and also below market value. Included in this amount is the stock dividend of 200 per cent on the outstanding capital. The dividend as originally declared amounted to $4,324,032.96, which was charged to the carrier's property-investment account as an offset to the carrier's liability for stock issued from which no funds were derived.

I do not desire to burden this committee with a recital of all the individual and particular acts of the railroads that have tended to make their present property investment of little value in determining fair and just earnings. The history of American railroads are replete with such transactions. If the committee so desires, however, innumerable other illustrations can be submitted from the official records of investigations of the New York Central, the Pennsylvania, the New Haven, the Rock Island, the Pere Marquette, the St. Louis & San Francisco, the Erie, and so on indefinitely.

Let me next explain the successive steps in the development of the authority of the Interstate Commerce Commission to deal with the accounting practices of the railroads.

This is important because it explains to a certain extent the property investment account of the railroads to-day.

As originally enacted the act to regulate commerce required interstate carriers to file annual reports with the commission covering specifically defined items. It also provided that the commission, in its discretion, might prescribe a uniform system of accounts for carriers subject to its jurisdiction. But the act contained no provision. for the enforcement of the orders of the commission in such matters.