1911 Encyclopædia Britannica/Railways/Financial Organization

Financial Organization

The methods of financing railway enterprises, both new projects and existing lines, have been influenced very largely by the attitude of the state and of municipal authorities. Railways may be built for military reasons or for commercial reasons, or for a combination of the two. The Trans-Siberian railway was a military necessity if Russia was to exercise dominion throughout Siberia and maintain a port on the Yellow Sea or the Sea of Japan. The Union Pacific railroad was a military necessity to the United States if the authority of the national government was to be maintained in the Far West. The cost of such ventures and the detailed methods by which they are financed are of relatively small importance, because they are not required to earn a money return on the investment. To a less degree, the same is true of railways built for a special instead of a general commercial interest. The Baltimore & Ohio railroad was built to protect and further the commercial interests of the city of Baltimore; the Cincinnati Southern railway is still owned by the city of Cincinnati, which built the line in the ’seventies for commercial protection against Louisville, Ky. From a commercial point of view such ventures are differentiated from railway projects built for general commercial reasons because they do not depend on their own credit. The government, national or local, furnishes the borrowing power, and makes the best bargain it can with the men it designates to operate the line.

Where a railway is built for general commercial reasons, however, it must furnish its own credit; that is to say, it must convince investors that it can be worked profitably and give them an assured return on the funds they advance. The state is interested in the commercial railway venture as a matter of public policy, and because it can confer or withold the right of eminent domain, without which the railway builder would be subjected to endless annoyance and expense. This governmental sanction has been obtainable only with difficulty, and after the exercise of numerous legal forms, in Great Britain and on the continent of Europe. In the United States, on the other hand, it has been obtained with considerable ease. In the earlier years of American railway building, each project was commonly the subject of a special law; then special laws were in turn succeeded by general railway laws in the several states, and these in turn have come to be succeeded in most parts of the country by jurisdiction vested in the state railway commission. Each of these changes has tended to improve the existing status, to legitimize railway enterprise, and to safeguard capital or investment.

The laws regulating original outputs for capital were strictly drawn in Great Britain and on the continent of Europe; in America they were drawn very loosely. As a result it has been far easier for the American than for the European railway builder to take advantage of the speculative instinct in obtaining money. Instead of the borrowing power being restricted to a small percentage of the total capital, as in European countries, most of the railway mileage of America has been built with borrowed money, represented by bonds, while stock has been given freely as an inducement to subscribe to the bonds on the theory that the bonds represented the cost of the enterprise, and the stock the prospective profits. As a natural result weak railway companies in the United States have frequently been declared insolvent by the courts, owing to their inability in periods of commercial depression to meet their acknowledged obligations, and in the reorganization which has followed the shareholders have usually had to accept a loss, temporary or permanent.

The situation in Great Britain has been wholly different. The debt in that country is relatively small in amount, and is not represented by securities based upon hypothecation of the company’s real property, as with the American railway bond, resting on a first, second or third mortgage. But British share capital has been issued so freely for extension and improvement work of all sorts, including the costly requirements of the Board of Trade, that a situation has been reached where the return on the outstanding securities tends to diminish year by year. Although this fact will not in itself make the companies liable to any process of reorganization similar to that following insolvency and foreclosure of the American railway, it is probable that reorganization of some sort must nevertheless take place in Great Britain, and it may well be questioned whether the position of the transportation system of that country would not have been better if it had been built up and projected on the experience gained by actual earlier losses, as in the United States.

Thus the characteristic defect in the British railway organization has been the tendency to put out new capital at a rate faster than has been warranted by the annual increases in earnings. The American railways do not have to face this situation; but, after a long term of years, when they were allowed to do much as they pleased, they have now been brought sharply to book by almost every form of constituted authority to be found in the states, and they are suffering from increased taxation, from direct service requirements, and from a general tendency on the part of regulating authorities to reduce rates and to make it impossible to increase them. Meantime, the purchasing power of the dollar which the railway company receives for a specified service is gradually growing smaller, owing to the general increases year by year in wages and in the cost of material. The railways are prospering because they are managed with great skill and are doing increasing amounts of business, though at lessening unit profits. But there is danger of their reaching the point where there is little or no margin between unit costs of service and unit receipts for the service. It will probably be inevitable for American railway rates to trend somewhat upward in the future, as they have gradually declined in the past; but the process apparently cannot be accomplished without considerable friction with the governing authorities. The attitude of the courts is not that the railways should work without compensation, but that the compensation should not exceed a fair return on funds actually expended by the railway. This is in line with the provisions in the Constitution of the United States regarding the protection of property, but the difficulty in applying the principle to the railway situation lies in the fact that costs have to be met by averaging the returns on the total amount of business done, and it is often impossible, in specific instances, to secure a rate which can be considered to yield a fair return on the specific service rendered. Hence losses in one quarter must be compensated by gains in another—a process which the law, regarding only the gains, renders very difficult.

The growth of railways has been accompanied by a world-wide tendency toward the consolidation of small independent ventures into large groups of lines able to aid one another in the exchange of traffic and to effect economics in administration and in the purchase of supplies. Both in England and in America this process of consolidation has been obstructed by all known legislative devices, because of the widespread belief that competition in the field of transportation was necessary if fair prices were to be charged for the service. But the general tendency to regulate rates by authority of the state has apparently rendered unnecessary the old plan of rate regulation through competition, even if it had not been demonstrated often and again that this form of regulation is costly for all concerned and is effective only during rare periods of direct conflict between companies. Nevertheless, in spite of difficulties, consolidation has gone on with great rapidity. When Mr E. H. Harriman died he exercised direct authority over more than 50,000 m. of railway, and the tendency of all the great American railway systems, even when not tied to one another in common ownership, is to increase their mileage year by year by acquiring tributary lines. The smaller company exchanges its stock for stock of the larger system on an agreed basis, or sells it outright, and the bondholders of the absorbed line often have a similar opportunity to exchange their securities for obligations of the parent company, which are on a stronger basis or have a broader market. Similarly in Great Britain there is a tendency towards combination by mutual agreement among the companies while they still preserve their independent existence.

Table XVIII. shows the paid-up capital, gross receipts, net receipts and proportion of net receipts to total paid-up capital on the railways of the United Kingdom for a series of years.

Table XVIII.—British Railways
Year Route
Miles
Paid-up
Capital
Gross
Receipts
Net
Receipts
Percent
Net to
Capital
1878 17,333 £698,545,154 £62,862,674 £29,673,306 4·25
1888 19,812 864,695,963 72,394,665 35,132,558 4·06
1898 21,659 1,134,468,462 96,252,501 40,291,958 3·55
1899 21,700 1,152,317,501 101,667,065 41,576,378 3·61
1900 21,855 1,176,001,890 104,801,858 40,058,338 3·41
1901 22,078 1,195,564,478 106,558,815 39,069,076 3·27
1902 22,152 1,216,861,421 109,469,720 41,628,502 3·42
1903 22,435 1,235,523,917 110,888,714 42,326,859 3·43
1904 22,634 1,258,294,681 111,833,272 42,660,741 3·39
1905 22,847 1,272,600,935 113,531,019 43,466,356 3·42
1906 23,063 1,286,883,341 117,227,931 44,446,077 3·45
1907 23,108 1,294,065,662 121,543,923 44,939,729 3·47
1908 23,205 1,310,533,212 119,894,327 43,486,526 3·32

A similar comparison (Table XIX.) can be made for the United States of America, statistics prior to the establishment of the Interstate Commerce Commission being taken from Poor’s Manual of Railroads as transcribed in government reports.

Table XIX.—American Railways
Year Route
Miles
Issued
Capital
Gross
Receipts
Net
Receipts[1]
Percent
Net to
Capital
1878 81,747 $4,772,297,349 $490,103,351 $187,575,167 3·93
1888 156,114 9,281,914,605 960,256,270 301,631,051 3·25
1898 190,870 10,818,554,031 1,269,263,257 407,018,432 3·76
1899 194,336 11,033,954,898 1,339,655,114 435,753,291 3·95
1900 198,964 11,491,034,960 1,519,570,830 509,239,944 4·43
1901 202,288 11,688,147,091 1,622,014,685 540,140,744 4·62
1902 207,253 12,134,182,964 1,769,447,408 598,206,186 4·93
1903 213,422 12,599,990,258 1,950,743,636 634,924,733 5·04
1904 220,112 13,213,124,679 2,024,555,061 623,509,113 4·72
1905 225,196 13,805,258,121 2,134,208,156 679,518,807 4·92
1906 230,761 14,570,421,473 2,386,235,473 774,051,156 5·31
1907 236,949 [2]16,082,146,683 2,649,731,911 820,254,887 5·10
1908 [3]237,339 16,767,544,827 2,393,305,939 651,561,537 3·88

 (R. Mo.) 

  1. After taxes; to compare with British figures.
  2. Includes $145,321,601 assigned to other than railway property, but earning net receipts.
  3. This figure should be received with caution. The Interstate Commerce Commission made certain accounting changes this year.