census years, with 1926 added for comparison, and emphasizes the fact that not once during this period have the average rates of either dividends or interest exceeded a reasonable figure.

Table showing the capitalization and the dividends and interest paid by the operating electric companies

2 Includes besides interest on floating debt the charges for amortization of debt discount and expense. 3 Excludes interest on floating debt but includes amortization of debt discount and expense,

As compared with earlier census years, the 1922 and 1926 rates reflect the higher return prevalent at the postwar price level, under decisions of the United States Supreme Court; also the high cost of financing during and immediately after 1917 and 1918, many securities then issued being still outstanding. Source:1 1902-1922, inclusive, from U. S. Census; 1926 N. E. L. A. shown for comparison.

To state the above-discussed matter in another way: The basic question for consideration is not whether any particular form of financial structure and consequent basis of distributing the reasonable net earnings of operating companies results in larger dividends to the holders of one or more classes of stockholders of the holding companies, but whether there is any casual relation, as claimed by the proponent of the resolution, between those dividends and alleged exorbitant rates charged to the public by the operating companies: in other words, whether a high percentage of dividends on the common stock implies rates yielding a like percentage of return on the operating properties. The contention of Senator Walsh is apparently that exorbitant rates are a necessity concommitant of high yield on a particular and limited class of stock.

The States, under the powers reserved by the tenth amendment, may authorize the ownership of stock of operating companies by holding or investment companies. A common stockholder is entitled to his pro rata share of the net earnings, after fixed charges and the dividends on any preferred stock. Those net earnings, and so the dividends, depend on rates limited by law.

What the holding company, as the owner of some or all of the common stock, may do with the dividends it receives thereon, by way of distributing them among the holders of its own stocks, does not increase or diminish the rates, the earnings, or the dividends of the operating companies.

The same amount of money may be, and is, divided by the holding company among the owners of its various classes of stocks according to the terms of their investment, based on their priorities, risk, and security. That is the prerogative of owners and investors. What is done by the holding companies is to divide the total amount of corporate revenues among different classes of security holders at varying rates of yield, based on priorities and risks.

The interest rates on the bonds and dividend rates on the preferred stocks are fixed and determined by conditions in the highly competitive security market and are not under the control of the holding company; and while they properly are lower than the dividends paid on the common stocks the holders of the bonds and preferred stocks are preferred and secured, while the holders of the common stock are at the risk of the business.

The investors who hold the bonds and preferred stock are not required to expend time, energy, or ability in connection with the financing, development, or management of the companies. The holders of the common stocks on which the larger dividends are paid by the utility companies and by the holding companies not only undertake the substantial risks of the enterprise but give time, ability, and energy to the successful management and operation of the industry and advance moneys for development and extensions which can be profitable, if at all, only as a "long-run " proposition.

Mr. LENROOT. Mr. Chairman, before Senator Walsh proceeds, may I make a request?

The CHAIRMAN. Certainly.

Mr. LENROOT. That request is to print a very short memorandum of citations of cases in which commissions and courts have spoken upon the question of effect of capitalization upon rates.

The CHAIRMAN. That may be done.

Mr. LENROOT. I hand it to the official reporter.

(The statement referred to is here made a part of the record, as follows :)

CAPITALIZATION AS INFLUENCING THE RATE BASE

An exhaustive review of all the cases in which commissions and courts have spoken on the subject clearly establishes the proposition that actually the security issues of a company in no manner whatever influence the price which the consumer pays for the service.

In Smith v. Ames, 169 U. S. 464, 42 L. Ed. 819, the Supreme Court of the United States expressed its view on valuation as follows:

"We hold, however, that the basis of all calculations as to the reasonableness of rates to be charged by a corporation maintaining 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 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 probable earning capacity of the property under particular rates prescribed by statute, and the sum required to meet operating expenses, are all matters for consideration, and are to be given such weight as may be just and right in each case "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 entitled to demand is that no more be exacted from it for the use of a public highway than the services rendered by it are reasonably worth." This is the only case where the Supreme Court has said that the amount and market value of bonds and stocks in a utility should be taken into consideration in fixing the value of that utility for rate making purposes.

THE KNOXVILLE CASE

* *

*

In this case, Knoxville v. Knoxville Water Co., 212 U. S. 1, 53 L. Ed. 379, the Supreme Court held that capitalization affords no guide to the value of tangible property used for rate making purposes. The court said:

"Counsel for the company urge rather faintly that the capitalization of the company ought to have some influence in the case in determining the valuation of the property. It is a sufficient answer to this contention that the capitalization is shown to be considerably in excess of any valuation testified to by any witness, or which can be arrived at by any process of reasoning."

This is the last reference made by the Supreme Court to capitalization as an element of value. Apparently, since then, it has been completely abandoned. The last case decided by the Supreme Court upon the question of valuation of public utilities is that of McCardle v. Indianapolis Water Co., 272 U. S. 400, decided November 22, 1926, in which the cost of reproduction theory was adopted and approved, and no reference whatever was made to capitalization.

FEDERAL COURT CASES

Numerous valuation cases have been decided in the United States Circuit Courts of Appeals since the decision of the Supreme Court of the United States in Smyth v. Ames, above cited. These decisions are practically unanimous in expression to the effect that capitalization is not a reliable index of the value of the plant, and, therefore, not an element to be considered in fixing a rate base. Some of these decisions are hereafter quoted in part.

LOUISVILLE AND NASHVILLE CASE

In Louisville and Nashville R. Co. v. Railroad Commission, 196 Fed. Rep. 820, the court said:

"In reference to the question of value with the view of rate regulation, the most reliable test ordinarily is the cost of the reproduction of the road as it exists * ** *。

"The market value of bonds and stocks while shedding in some cases light on the question of present value, can not, except in a very slight measure, indicate what that value is as a matter of fact. The market value of stocks and bonds merely shows the public estimate of the value of the whole property contributing to the income, which may, as in the case of the Louisville & Nashville Railroad, embrace millions of dollars of property not used as a common carrier. And this public opinion is also open to the influence of stock jobbing manipulation and artificial bookkeeping, without the advantages of sworn inventories and the precise testimony of competent and disinterested witnesses on exact inventories of existing property. A road may have a small amount of stock compared to its property, as in the case of the amount of bonds against its property, and the two combined may not, with premiums or discounts taken into consideration, indicate with any accuracy the present values of the property invested in the business and used as a common carrier."

In Spring Valley Water Works v. City, etc., of San Francisco (192 Fed. Rep. 145), the court said:

66

'The aggregate value of bonds and issued capital stock of the company at present market prices is not a reliable index of the value of the plant, because such prices often rise and fall from the operation of causes which have little or nothing to do with the real intrinsic value of the property, and the bonded or other indebtedness of the company may exceed the actual value of its property."

CAPITALIZATION NOT VALUE

In Texas and Pacific Railroad Co. v. Railroad Commission (192 Fed. Rept. 286), the court quotes from the State judge as follows:

"Complainant has also failed to shop its investment in Louisiana, except to fix the amount of its outstnading stock and bonds, which should not be taken as conclusive proof. As against this, there is evidence tending to show that complainant has constructed a branch railroad in Louisiana from Cypress to Shreveport, a distance of 81 miles, at an average cost of $20,405 per mile; and it is shown that its road is returned for taxation at $10,000 per mile for its main line and $5,000 per mile for its branches."

Then the court approves this statement by the State judge in the following language:

"That the judge is right in holding that this is not a satisfactory way to reach the true value of railroad property seems to us clear."

STATE COMMISSION RULINGS

State public utilities commissions, almost without exception at the present time, hold that capitalization is not a real factor in determining the rate base. While the proposition is differently stated in the cases, the conclusion is the same, as is indicated in the following citations, all references being to State public utility reports:

ALABAMA

Capitalization is not accepted at all in determining the rate base. It is "immaterial." (1923, B 28.)

*

COLORADO

Little "if any consideration was given capitalization. (1920, D 197.) "The issue by that company of the enormous amount of $11,000,000 par value of common stock * * was sufficient to put the commission upon inquiry whether this represented the actual value" and made it the plain duty of the commission to ascertain the present value of the plant. (1920, D 197.)

CONNECTICUT

If it appear that the security issues of a company are in excess of the fair value of the property, no weight whatever is attached to securities. (1919, D 193.)

GEORGIA

The weight given to capitalization in 1918 I was about nil, and the weight to be given to it now is less than in 1918." (1921, A 165.)

“Absolutely no consideration" was given to bonds and stock. (1925, A 546.)

ILLINOIS

Capitalization is no guide." (1917, B 1.)

If it appear that the security issues of a company are in excess of the fair value of the property, no weight whatever is attached to securities. (1918, B 172.)

The rate base should not be fixed simply to meet interest on outstanding bonds, because there was no guaranty that the rate base would be fixed to pay such interest. (1920, F 139, 152.)

Capitalization can not be given effect to modify the valuation based upon other elements. (1921, A 446.)

66

INDIANA

Little, if any, consideration was given capitalization. (1917, B 306.) Capitalization has no direct bearing on rates, but only throws light on the method and management." (1918, E 669.)

66

Practically disregarded" and considers only structural value and overheads. (1921, E 144.)

66

Commission never determines rate upon the debts of the company." (1925, B 345.)

MAINE

Capitalization is really not a factor for consideration. (1918, C 246.).

MARYLAND

Capitalization may be considered a factor and of considerable weight, where evidence showed that all of the proceeds went to build up the property. (1916, C 1009.)

Market value of stock and bonds did not furnish a standard by which property values might be measured. (1918, F 582.)

Capitalization "is given practically no consideration in the making of rates." (1921, D 705.)

MASSACHUSETTS

Consideration was given to capitalization, evidently because the prudentinvestment theory was favored and applied in cases by the Massachusetts Department of Public Utilities. (1916, F 253.)

Capitalization under commission supervision was given weight on ground it had been approved by public authority. (1917, A 337; 1919, D 844.)

MICHIGAN

If it appear that the security issues of a company are in excess of the fair value of the property, no weight whatever is attached to securities. (1923. A 30.)

Paid-in capital and financial history and operating performance of the company are of considerable importance and will be given careful consideration, but must be taken into consideration with many other factors which affect the result. However, the commission said that in the present case we do not regard cither element (amcunt of outstanding stocks and bonds and their market value) as of much importance." (1923. C 471.)

Little, if any, consideration is given to capitalization. C' 808.)

(1923, D 276; 1924,

May not impose burden of increased rates to realize profit on excessive valuation and fictitious capitalization. (1923, A 30, E 282.)

The Federal District Court said: "We reject entirely the whole subject of capitalization, stocks, and bonds. We fail to see how it can have any perti nence." (1923, E 661.)

MINNESOTA

practically disregard any stock issues."

MISSOURI

The practice of the commission is to (1923. C 817.)

Little (if any) consideration was given market value of stocks and bonds. (1917, C 760.)

66

Capitalization is really not a factor for consideration."

G. & E. Co.; 1924, B 338; 1927, B 1.)

(1919, Re Missouri

"It is not a factor at all unless supplemented by evidence."

(1924, B 339.)

MONTANA

"It is needless to say that sums obtained by the sale of securities have no wise influenced our determination." (1920, D 668.)

If it appear that the security issues of a company are in excess of the fair value of the property no weight whatever is attached to securities. (1922, B 367.)

NEW HAMPSHIRE

"No importance can be attached to stocks and bonds." (Re Exeter Water Works.)

Where securities were issued with governmental approval, they were accorded some weight when the rate-making value then found compares favorably with that of like companies per mile of road. (1917, A 360.) "Capitalization is really not a factor for consideration.”

(1918, C 246.)

A slight modification of the general rule appears in this case, where the commission said that capitalization may be considered a factor and of considerable weight, where the securities were issued with governmental approval. (1917, D 777.)

The commission said “the injection of water can not add one cent to the value of the property which is actually used and that is the only inquiry which the commission here is interested in." (1919, A 761; 1923, B 773.)

(1920,

If it appear that the security issues of a company are in excess of the fair value of the property no weight whatever is attached to securities. D 515.)

66

'No importance can be attached to stocks and bonds." (1924, D 14.) 'Capitalization should have only small relation." (1925, D 407.)

NORTH DAKOTA

Capitalization is not accepted at all to determine the rate base.

B 495.)

OREGON

(1923,

Stocks and bonds have no bearing on value of the property. (1918. A 751.) The commission said it was "concerned with the fair value of the property rather than the amount of stocks and bonds issued." (November 29, 1919.) Commission is concerned with fair value of property rather than amount of stocks and bonds. (1920, F 460.)