Definition of railroad reorganization

A general survey of railroad reorganizations may now be attempted.
Eighteen different ones and no less than forty-two reorganization plans
have been examined in detail. In their seemingly infinite variety
may not some guiding principles be found which will assist both in
interpreting the past and in directing the future?[680]

It is apparent that a readjustment of a railroad’s affairs is more
difficult than the readjustment of those of an individual. A railroad
is a complex financial, as well as a complex operating machine.
Especially when it has been built up by the union of numerous small
properties, each of which has been allowed to retain a certain
individuality of its own, are the relations between the different
parts intricate and involved. The obligations which have been incurred
in the course of its career, and the kinds of paper which represent
these obligations, disclose a variety which the debts of an individual
seldom or never present. This complexity in railroad capitalization
inevitably leads to clashes in interest between different classes of
securityholders. Divergencies in interest seem to appear even while a
road is solvent. If classes of securities exist upon which payment of
interest is optional, it is to the advantage of the junior issues to
prevent payment of interest or dividends upon others until earnings
are such that payment may be made upon all. If common stockholders
can reinvest in the property sums which normally would be paid in
dividends on the preferred stock, they advance the day upon which
they can secure dividends for themselves at the expense of their
seniors. The same situation may also arise as between the preferred
stock and the income bonds. Or, again, it may be to the advantage of
speculative stockholders to pay dividends to themselves by means of the
accumulation of a floating debt, and to sell out at top quotations,
leaving the floating debt to take precedence even of mortgage
bonds.[681] Both this and the preceding operation are facilitated
by the control which the least valuable portion of the capital, the
common stock, usually has over the policy of the entire company. But
it is when a reorganization becomes necessary that these conflicts
in interest become most apparent, and it is as a compromise between
contending forces that a reorganization plan must take its shape.

The term “reorganization” is used in this study to denote the exchange
of new securities for the principal of outstanding, unmatured, general
mortgage bonds, or for at least 50 per cent of the unmatured junior
mortgages of any company, or for the whole of the capital stock. These
exchanges have been the essential features of the operations which
have been described. This exchange of securities must take place upon
a considerable scale. Small readjustments may involve valuations of
specific bits of property, but they do not require that comprehensive
survey of the relations of all parts of the system to each other
which distinguishes the general reorganization. In fact, the small
adjustments are at once more simple and more difficult than the larger
kind. More simple because they involve less change; more difficult
because the same pressure cannot often be brought to bear. It is useful
to mark a dividing-line between the small and the large. No such
line can be defended as exact; but the one chosen seems to include a
tolerably homogeneous group, and will lend a convenient definiteness to
the discussion.

As thus defined, a reorganization may be, and generally is, accompanied
by other operations essential to its success. If a large floating debt
has been accumulated, provision for the cancellation of this debt must
be made;[682] if unprofitable leases have been entered into, these
must be abolished;[683] or if the system has been unduly hampered by
inability to issue new capital, appropriate relief must be afforded.
But none of these are determining features. They are means to an end,
as is the exchange of new securities for old, and they may have their
effect just as the economical management of the Union Pacific under
Charles Francis Adams had its effect in the years prior to 1890; but
they are not essential parts of that group of operations which have
been characterized as reorganizations.

The exchange of new securities for old on a large scale usually takes
place when a railroad is unable to meet maturing obligations. Of 18
reorganizations and 42 plans, 15 reorganizations and 39 plans have had
to do with the extrication of companies from financial embarrassment.
But though impending insolvency is the usual occasion it is not the
only one. Reorganization sometimes occurs when prosperity is too great
as well as when it is too little. Or a management may desire to get
rid of hampering restrictions, or it may desire to manipulate the
conditions of control. This last named cause—the desire to manipulate
conditions of control—has been fortunately an infrequent cause of
reorganization. An example is, however, afforded by the Rock Island
reorganization of 1902. It will be remembered that the Chicago, Rock
Island & Pacific Railway had long been a prosperous road in the Middle
West, and that its control had required the ownership of between 40
and 50 per cent of $75,000,000 of common stock, quoted at over 160
in the early part of 1902. By the issue of new bonds, new preferred
and new common stock to a total of $270 for every $100 of old common
stock, and by giving to the preferred stockholders the right to elect
a majority of the directors, the owners of the property were able to
part with a large portion of their holdings and yet retain absolute
control. A somewhat similar case was that of the Chicago & Alton. This
road had been a conservatively capitalized enterprise, doing a large
business between Chicago, St. Louis, and Kansas City. It had paid 7
per cent or better on its two classes of stock for eighteen years
without a break, and had accumulated in that time an uncapitalized
construction expenditure of $12,444,178. In 1899 a syndicate of Eastern
capitalists bought control, and the following year reorganized the
property by forming a holding company, which issued $22,000,000 in 3½
per cent bonds, $19,489,000 in preferred and $19,542,800 in common
stock to exchange for the $22,230,600 old common and preferred shares
outstanding. At current prices on January 3, 1899, a majority of
both the old issues would have cost $19,030,048; on January 4, 1901,
however, a majority of both of the new issues represented an investment
of $10,729,437; and this investment it would have been possible to
reduce to $2,241,377 by the sale of the new bonds received, without in
any way endangering control.[684]

It is evident that both the Rock Island and the Chicago & Alton
reorganizations were influenced by the very great prosperity of the
companies concerned. It was desired to reap a profit by the sale
of new securities as well as to lessen the investment required for
control; although it may be remarked that the advantage of retaining
control depended on the future prosperity of the roads. Reorganizations
concerned with manipulation of control are therefore closely allied
with reorganizations due to too great prosperity. These latter may,
however, take place independently, and are likely to occur whenever
profits are extraordinarily large, and a simple stock dividend is
deemed inadvisable. An example was the reorganization of the Chicago,
Rock Island & Pacific in 1880, when the formation of a new company and
the exchange of new stock for old was deemed wise, in view of the large
earnings which were to be distributed.

The desire to eliminate hampering restrictions is seldom the sole
cause for a reorganization, but frequently it is a contributing one.
When, for instance, the managers of the Union Pacific wished to
extend their system in the years following 1880, they were forced
to establish a separate organization for each branch line. By the
terms of the charter nothing could be consolidated with the main stem
except the Kansas Pacific and the Denver Pacific, the consolidation
with which was provided for in the original acts.[685] This obviously
prevented considerable economies, and could be remedied only by a
new incorporation. The Northern Pacific was hampered in yet another
way because the consent of three-fourths of the preferred stock was
required by the terms of the reorganization of 1875 to the imposition
of new mortgages;[686] and similarly the Atchison, after 1889, found
it extremely difficult to issue new bonds because of the position of
the outstanding income bonds. In this last case the restriction was the
sole cause of the reorganization which followed. It should be remarked
that the cancellation of such provisions sometimes works considerable
injustice. Restrictions on future increases in capital, for instance,
may have facilitated the issue of bonds in the past, and in this case
have formed part of the consideration given for subscriptions. The
readjustment is defended on the ground of the need of the corporation,
or is so accomplished as not to lessen the value of the creditors’
holdings.[687]

The typical railroad reorganization, as has been said, occurs when a
road ceases to be able to pay interest on its outstanding obligations.
Whether because of excessive capitalization or because of unexpectedly
low earnings, or owing to an accumulation of floating debt which ties
up all current resources, the reorganizing railroad finds itself
incapable of meeting payments falling due. For this, experience shows
that two deep-seated causes have generally been responsible. First,
there is the almost entire freedom in matters of capitalization which
railroads have enjoyed. Far from the recommendation of Secretary Taft
that no railroad company engaged in interstate commerce be permitted
to issue stock or bonds and put them on sale in the market except
after a certificate by the Interstate Commerce Commission that the
securities are issued with the approval of the Commission for a
legitimate railroad purpose,[688] American railroads have in the past
been practically unrestricted. It was open to the Erie to increase
its capitalization per mile from $81,068 in 1864 to $117,760 in 1872,
with no corresponding addition to its property; it was open to the
Union Pacific to create a capitalization of $104,561 per mile by 1870,
of which about one-quarter was in the form of government bonds; and
it was possible for the Atchison to issue $129,162,350 in new bonds
and stocks between 1884 and 1889 while its net earnings seriously
decreased. Had there been a supervision of new issues, or had even a
certain percentage of stocks to bonds in those instances been required,
failures would have been less frequent and reorganizations less common.
New construction would probably have been less rapid, but not so much
so as is often asserted. A smaller number of new enterprises might have
yielded larger profits; the chances for land speculation might have
tempted many, and liberal regulations might have allowed a generous
profit while at the same time eliminating all inflation due to fraud.
Unfortunately railroad-hungry communities seldom stopped to count
the cost. West, South, North, and East, privileges were offered to
railroads, donations of land and money were made, and exemptions from
taxation were conferred.

The second fundamental cause of railroad distress has been competition.
If unrestricted capitalization has increased the load which the
railroads have had to bear, unrestricted competition has impaired their
ability to support any load at all. The forms which this competition
has taken have been mainly two: first, the cutting of rates, either
openly or by secret concessions; second, reckless extensions of line,
generally followed by rate-cutting. The cutting of railroad rates
is now a subject familiar to all. Illustrations may be found in the
history of any great railroad system. President Hadley has made
classical the theory that roads will take business until rates fall
below the specific cost of hauling a given shipment; that is, below
the additional cost which the articles in question impose. Even this
limitation is often non-existent. Railroads which serve different
cities will take freight when a war is in progress whether or not the
rate repays the specific cost of hauling. If their rival imitates
them they hope to wear it out by their superior ability to stand the
loss. If it does not, the city which they serve will temporarily eject
all others from common market, and may obtain so firm a footing that
a permanent increase in business will result. All of the railroads
which have been studied, in fact, have suffered more or less from
rate-cutting. Repeated attempts at pooling and agreements to maintain
rates have improved conditions only during the short periods in which
the agreements have been of effect. In the South there have been
scarcely more successful attempts to secure harmony by community
of stock control. Competition by means of extensions has been also
vigorously practised. The reader will recall the growth of the Atchison
from 1884 to 1889. It was after the dissolution of the Southern Railway
Security Company that the East Tennessee entered upon its policy of
purchase and of new construction. The entrance of the Reading into New
England was the direct cause of its failure in 1893; and that of the
Baltimore & Ohio into New York largely contributed to its difficulties
in 1887. Sometimes such extension is into territory where there is no
business to justify it. Sometimes the business is there, but has to be
divided among too many rivals. Sometimes the new lines are so poorly
built as to be unduly expensive to work, and not infrequently they
are so good that the resources of the expanding road are strained in
acquiring them. In any one of these four cases new extension causes a
drain upon the parent road which may readily bring about its failure.

Other conditions may lead to railroad failure. Simon Sterne alleges the
following causes to be often responsible:[689]

1. The control of railroads by stock which represents little or no
original cash investment.

2. The development of the territory served by individual railroads at
a slower rate than is anticipated, and the influence of competition in
reducing profits when the territory has developed.

3. The undertaking of railway construction when there is considerable
activity in the money market, and when capital commands a high rate of
interest.

4. The circumstance that railways, lacking reserve capital, can never
avail themselves of a cheap market for labor or supplies, but must
always buy when everything is inflated, because then only can they
float their loans and borrow capital.

5. The necessity of complete reconstruction within a brief period of
most railroads built through new territory, and the increase in funded
and in floating debt involved.

7. The growth of railroads beyond the ability to handle them.

8. The steadily increasing expenditures required by law to accommodate
the public.

9. The abuse of their position by directors and trustees.

10. The irresponsibility of railway accounts.

And it may be added that the control of American railways by foreign
investors who apportion charges between operating and capital accounts
in a way unsuited to American conditions has been upon occasion a
cause of disaster. Unlimited freedom in matters of capitalization and
unrestricted competition have nevertheless been the fundamental causes
of bankruptcy.

It is interesting to observe that the majority of the principal
railroads which failed in the nineties had taxed their resources nearly
to the point of exhaustion before the panic of 1893 finally drove them
to the wall. For every $100 received in 1892 the Richmond & Danville
and East Tennessee systems were paying out $68.79 for operating
expenses and $31.15 for interest on bonds, rentals, etc., leaving only
6 cents for dividends, necessary improvements, and the like. For every
$100 received the Erie paid out the same year $66.46 for operating
expenses and $31.85 for interest and other fixed charges, leaving only
$1.68 as a surplus to ensure solvency in case of a decline in earnings.
In 1893 the Atchison, the Northern Pacific, the Reading, and the Union
Pacific had no surplus at all, but rather a deficit. The following
table shows similar figures for all of our reorganized roads:

_Percentage to Gross Income_

1893 1892
_Operating _Fixed _Surplus_ _Operating _Fixed _Surplus_
Expenses_ Charges_ Expenses_ Charges_

B. & O. 66.89 24.27 8.83 67.68 24.55 7.76
Erie 64.91 32.12 2.96 66.46 31.85 1.68
N. Pac. 59.25 43.55 53.71 36.34 9.94
Reading 57.04 45.41 52.64 33.91 13.44
Rich. 73.49 25.63 .12 68.79 31.15
& Danv.
and E.
Tenn.
U. Pac. 59.66 43.18 51.91 36.42 11.66
Atchison 77.47 24.96 77.16 21.59 1.24[690]

With these figures may be compared statistics for seven roads which
went through the depression of 1893–7 without failure. These roads
had a more extensive margin which could be cut off before interest on
their bonds should be endangered. Furthermore, this margin was secured,
not by low operating expenses, but by low fixed charges, including
interest on bonds. Operating expenses averaged higher than for the
preceding group, fixed charges averaged much lower. In the first group
but one road had charges in 1893 which were less than 25 per cent of
gross income; in the second group but two roads had charges which were
greater. The condition of the roads of the second group referred to was
as follows:

_Percentage to Gross Income_

1893
_Operating _Fixed
Expenses_ Charges_ _Surplus_

C., B. & Q. 64.46 23.12 12.41
C., M. & St. P. 65.95 20.78 13.26
C., R. I. & P. 71.72 13.31 14.96
Great No. 50.44 34.54 15.01
Ill. Cen. 61.92 25.84 12.23
N. Y., N. H. & H. 72.31 16.07 16.36
N. Y. C. 68.79 20.84 10.36

1892
_Operating _Fixed
Expenses_ Charges_ _Surplus_

C., B. & Q. 65.17 20.86 13.96
C., M. & St. P. 64.00 22.36 13.63
C., R. I. & P. 69.88 19.83 10.28
Great No. 52.66 32.98 14.34
Ill. Cen. 64.58 23.99 11.12
N. Y., N. H. & H. 73.36 8.77 17.86
N. Y. C. 68.46 21.53 9.96

The causes which lead to railroad failure have now been mentioned.
When bankruptcy has at last occurred, three groups of interests take
part in the reorganization which must ensue. These are the creditors,
who find interest and perhaps principal of their bonds in default;
the stockholders; and the bankers and financiers who advance ready
money and subscribe to necessary guarantees. Of these the creditors
and the stockholders are widely scattered, and are quite unable
to protect themselves by individual action. Their first impulse
is, therefore, either to elect committees to represent them, or to
authorize self-appointed committees of well-known men to look after
their interests. Stockholders in a reorganization have little voice.
They are the owners, and all that the corporation has is subject first
to the bondholders from whom it has borrowed money. Occasionally
they seem to make their influence felt. In 1880 the Reading actually
attempted to pay off its floating debt by bonds with a lien inferior to
the common stock; and in 1892 the Olcott plan for the reorganization of
the Richmond Terminal Company strongly favored the junior securities.
But as a rule stockholders must accept, and rightly, about what the
creditors desire.

The creditors, then, are the most important factors, and they, like
the stockholders, act through committees. There may be a committee for
every class of bonds, or one or more classes may join together. The
Union Pacific, in 1893, had committees for the consolidated first
mortgage, the collateral trust 5s, the Oregon Railway & Navigation
consols, the Dutch bondholders, and certain branch lines; and in 1894
for the collateral trust 4½s and the Kansas Pacific consols. As the
financial situation grew worse the interest on senior mortgages became
imperilled, and even the Union Pacific first mortgage bondholders
deemed it wise to elect a committee; while a second committee arose
for the Kansas Pacific consols, and a new committee for the Denver
Extension mortgage. By April, 1895, at least fifteen committees were
in active operation, of which fourteen represented not more than
two classes of bonds each. The Reading reorganization of 1884 to
1886 was largely shaped by two committees representing the general
mortgage bondholders; seven reorganization trustees representing
the foreign creditors, the general, income, junior securities, and
stockholders; and an opposition committee known as the Lockwood
Committee. Within four months after the failure of the Erie in 1875
the English bondholders and stockholders each had elected a committee,
and had urged all securityholders to join; a meeting of bondholders
had elected Mr. John Hooper chairman of a committee in New York;
and another meeting had elected Mr. N. B. Lord chairman of another
committee in that city.[691] The more general a committee the greater
the influence which it seems able to exert on reorganization, and
the greater the likelihood that the plan which it approves may be
accepted. The fact that a scheme has to meet the criticism of opposing
interests during its formation renders it less likely to contain
any injustice which conditions make it possible to avoid; and the
endorsement of their representatives makes all classes of bondholders
more ready to accord it temperate consideration. Among the numerous
Union Pacific committees it was the joint committee, representing
the foreign holders, the Denver & Rio Grande, the Oregon Railway &
Navigation, and other interests that took the leading part. In the
case of the Reading from 1884 to 1886 the seven reorganization trustees
outweighed any other representatives of the creditors; in that of
the Northern Pacific the Adams Committee succeeded in becoming a
general reorganization committee, and took the leading part; and the
Atchison reorganization was accomplished only by the union into a joint
executive reorganization committee of three of the previously existing
bodies.[692]

The situation which bankers and financiers occupy in relation to a
bankrupt road is almost equally important. Their aid is essential to a
reorganization while that of the officers and receivers of the company
is not. And they are not subject to the pressure of imminent financial
loss which forces creditors and stockholders to accept plans of which
they do not altogether approve. It is true that these bankers may have
money invested in the securities of the road. It may even happen that
they have been formerly in control. In this case a certain pressure
does exist. But as bankers their function is to do one or both of two
things; namely, to advance cash to keep the railroad system together
pending reorganization, and to underwrite assessments or the sale of
securities. Either one of these involves them in new risks, and in
undertaking either they will be only indirectly affected by investments
which they may previously have made. Their influence on reorganization
is strong because they are necessary, and because they are free to
participate or not to participate according to their opinion of the
precise reorganization plan proposed. For much the same reason their
influence is a wholesome one. We shall see that the primary conflict
which takes place in any reorganization is between the interests
of the corporation which needs a lessening of its burdens, and the
interests of the securityholders which is opposed to any reduction in
their claims.[693] The degree to which the former interest prevails
determines the strength of the reorganized company. In this conflict
the bankers naturally take the side of the company. As bankers, who
advance cash, and who usually receive their pay in securities, they
wish to make the corporation prosperous, and to raise the quotations
of its securities to a high figure. An important factor also is that
as reputable banking firms they wish the future career of corporations
which they have handled to reflect credit upon themselves.

An example of the influence of bankers and financiers appears in
the case of the Union Pacific. A committee comprising General Louis
Fitzgerald, Jacob Schiff, T. J. Coolidge, Oliver Ames, and two railway
presidents took the road out of receivers’ hands, cut charges per
mile by over one-half, and paid the Government’s claim in full. The
Reading reorganization of 1886 to 1887 was the work of a syndicate
which took hold after interests closely connected with the properties
had failed to produce a satisfactory plan. The result was the best plan
ever applied to the Reading Railroad. The Richmond Terminal Company
was reorganized by a single banking firm. In this case the operation
cut charges less than could have been desired, though the other
parts of the plan were well-advised. The intervention of a syndicate
has fortunately been usual of late years. And it is doubtful if the
compensation accorded has been exorbitant, even for the direct services
rendered. In 1886 the Reading agreed to pay a syndicate 5 per cent
upon $15,000,000 of subscribed capital, plus 6 per cent on all money
advanced. The Richmond Terminal paid Drexel, Morgan & Co. $100,000 in
cash to cover their office expenses and $750,000 in common stock at $15
per share[694] for their work of coöperation and supervision. The Union
Pacific paid the syndicate which financed its reorganization $5,000,000
in preferred stock quoted at 59, or 19 per cent at current prices on a
subscribed capital of $15,000,000. All three syndicates, however, ran
the risk of depreciation in the value of the stock given them, and all
three rendered great service in providing large sums of cash at a time
when capital was not readily to be obtained.

Payments to bankers or trust companies receiving deposits of bonds
and stocks and undertaking the clerical work of a reorganization,
should be sharply distinguished from those made to underwriting
syndicates above described. Depositaries assume no risk, and are paid
a definite sum for definite services performed. In 1895 the Erie set
the compensation of Messrs. J. P. Morgan & Co. and J. S. Morgan &
Co., for their services as depositaries and in carrying out the plan
of reorganization, at $500,000 in addition to all expenses incurred;
and the same year the Union Pacific allowed $1,000,000 in preferred
stock to the bankers who managed its underwriting syndicate, as
against $5,000,000 to the syndicate itself. It should be said that
the compensation to depositaries is in part payment for the use of the
name of the firms employed as well as in part payment for clerical work
performed. Bondholders are more ready to deposit their securities with
a well-known house than with an obscure one; and are to some extent
influenced by the implied approval of the reorganization plan which
acceptance of deposits by such houses involves.

At the beginning of the ordinary reorganization, then, creditors,
stockholders, syndicate, and corporation find themselves face to
face. The interests of the syndicate and of the corporation most
nearly coincide except in so far as the syndicate is an owner of
stocks or bonds. The syndicate desires a radical reorganization,—
the corporation requires it. But as between stock- and bondholders
and the corporation; between the stockholders and the bondholders;
or between the junior and the senior bondholders; there is well-nigh
complete antagonism. The corporation, to repeat, needs a reduction in
the fixed charges which it has to pay. The securityholders wish to lose
as little as possible. The stockholders hope to force sacrifices from
the bondholders, and the bondholders to levy a heavy assessment upon
the stock. The junior bondholders call upon their seniors to bear their
part; and the seniors reply that they are well secured and that the
juniors and the stock must take care of themselves.

The first question which arises is that of the cash requirements.
How much cash must be raised to pay off the floating debt, and how
much working cash capital will the new corporation require? It is
almost always true that a large floating debt has accumulated prior
to reorganization. The Northern Pacific in 1893 had a gross debt of
no less than $15,000,000; the Reading in 1895 one of $13,800,000;
the Baltimore & Ohio in 1896 one of $13,000,000; the Atchison in
1893 one of $16,000,000. In part this means simply the accumulation
of unpaid bills. In part, however, it represents promissory notes or
other short time paper which the corporation has issued, generally
to pay current indebtedness, but occasionally for financing somewhat
extensive operations. Thus Mr. McLeod carried his purchases of New
England railroad stock by means of advances from brokers, and the
Government Directors of the Union Pacific reported that $15,000,000
out of $21,400,000 of floating debt of that road in 1891 were the
result of expenditure and advances in the construction of branch or
tributary lines. The cost of carrying such indebtedness is naturally
high. Mr. McLeod is reported to have paid an average of 9 per cent
for his loans. The reorganization committee of the Atchison stated
in 1895 that during the five years preceding, the road had paid
over $1,100,000 in discounts and commissions to secure the renewal
of $9,000,000 of guarantee fund notes. And floating indebtedness is
by far the most dangerous as well as the easiest sort of obligation
to incur. It represents a possible demand for large sums of cash on
short notice which even a solvent company may find it impossible to
meet;—a demand, moreover, which is likely to be made at a moment
of stringency in the money market. For this reason, and on account
of the high interest demanded, corporations endeavor to fund their
floating debts when these reach unwieldy proportions. In 1891 the
Union Pacific authorized three-year 6 per cent notes to the amount of
$24,000,000 to be used in taking up its floating debt. In 1893 the
Northern Pacific authorized $15,000,000 collateral five-year 6 per
cent notes for the same purpose. In each case it was hoped to refund
these short time issues with bonds of longer term when the date of
their maturity should arrive. After a company has been in receivers’
hands, issues of receivers’ certificates are pretty sure to swell
the current liabilities. These, again, may be issued to pay current
bills, or to maintain or to improve the railroad when other resources
prove insufficient. For whatever reason incurred, it is plain that the
problem of the floating debt is a serious one for the creditors and
owners of a bankrupt road to meet. If the provision which they make is
insufficient their company will not regain a safe financial footing.
And if, in addition to cancelling the debt outstanding, they do not
provide a margin for working capital, the company will be forced to
incur new floating debt and their work will have to be done over again.

In general there are two ways by which cash for floating debt and
working capital can be raised:

(1) By assessment on securityholders. (2) By the sale of securities.

Sales of securities may comprise the sale of securities of the
bankrupt, or of other corporations held in that company’s treasury,
or they may be sales of part of new bond or stock issues reserved for
that purpose. In 1898 the Baltimore & Ohio sold among other things
$3,800,000 of Western Union Telegraph stock held in its treasury since
1887; while in 1889 the Atchison issued and sold $12,500,000 general
mortgage 4s and $1,250,000 income 5s. When outside securities are sold
the value of which is in no way dependent upon the prosperity of the
road which sells them; and which are such, moreover, as the selling
road can readily spare, this method of raising capital is open to few
objections. Its chief disadvantage is that the sale is apt to be made
at a time when the level of general prosperity is not high, and the
price obtained is therefore apt to be low. But the question is quite
different when the securities are those of the embarrassed or bankrupt
road itself. In this case the credit of the company and the price of
its securities are sure to be at a low ebb. The initial sacrifice
entailed is necessarily great; while if the securities sold are bonds,
as they are almost sure to be, the company increases its annual
interest charge without receiving an equivalent value in return. If, on
the other hand, the railroad endeavors to prevent a rise in charges by
the use of income bonds or stock, the gain is usually neutralized by
the extremely low price obtained.[695] In general we may say that sale
of a railroad’s securities in time of general depression is impossible
except at a ruinous sacrifice; that sales should not be resorted to at
all except when the road’s difficulties are acute rather than chronic,
as in the case of the Reading in 1896; and that when securities are to
be sold the best of the available bond issues should be used and not
the worst.

The case of an assessment is very different. Securities may be sold
to outsiders or to present securityholders. In the one event no
pressure at all can be brought to bear; in the other only that of the
indirect loss which the difficulties of the reorganizing company would
involve.[696] An assessment, on the other hand, is levied solely on
securityholders and is compulsory. Stockholders or bondholders who
refuse to pay are ordinarily debarred from all participation in the
reorganization, and lose all chance to recoup their losses from their
share in subsequent prosperity. In return for the assessment some
security is usually given, so that from one point of view an assessment
and a sale resemble each other. But the element of compulsion appears
in this: namely, that in the case of a sale the new securities are
taken at the buyers’ valuation; but in the case of an assessment the
company determines what it shall give for the cash paid in. Hence the
usual compensation for an assessment is an equal nominal amount of
preferred stock;—while that for the purchase money in a sale is a
greater nominal amount in bonds. Either an assessment or a sale of
securities may be fortified by a syndicate guarantee. In the one case
the syndicate agrees to substitute itself for all non-assenting or
defaulting stock- or junior bondholders; in the other it engages to
take and dispose of the new securities offered, or such part of them as
the company is unable to sell. The advantages of syndicate assistance
we have already discussed.

It will be recalled that both assessments and sales of securities have
been freely employed in the reorganizations which have been considered,
and that syndicate guarantees have been of ordinary occurrence. Out
of eighteen reorganizations, fourteen were forced to pay attention
to the raising of cash; the four which did not consisting of the
consolidation of the Union Pacific with the Kansas Pacific and of the
Chicago, Rock Island & Pacific with its branch lines in 1880, the
income conversion reorganization of the Atchison in 1892, and the Rock
Island reorganization of 1902,—each a reorganization of a more or
less peculiar nature. Of the fourteen remaining, four provided cash by
assessment, three by the issue of securities, and five by a combination
of both methods. Adding to this the Northern Pacific reorganization
of 1896 and that of the Erie in 1859, which combined an assessment
with funding provisions, we have eleven reorganizations which relied
on assessments in whole or in part. This preponderance is, however,
due to the extensive use of assessments from 1893 to 1898; since the
earlier reorganizations show assessments in only about one-half of
the cases. This does not mean that the value of an assessment was not
understood before 1893. For the reorganization of the Northern Pacific
in 1895 was otherwise so radical that an assessment was less necessary;
and that of the Atchison in 1889 took place at a time when business
conditions were not in general depressed. The effect of widespread
depression on the means employed for raising cash is, however,
perfectly clear.[697]

Of the reorganizations of 1893 to 1898, to repeat, there was none which
we have considered which did not make use of assessments. The following
table shows the amount and distribution thereof:

_Assessments, 1893–8_

_Common _1st _2d
Stock_ Preferred_ Preferred_ _Junior Securities_

Atchison $10 $20 4 per cent on 2d
mortgage and income
B. & O. 20 $2
Erie 12 8
N. Pac. 15 10
Richm. Term. 10
E. Tenn. 7.20 3 6
Reading 20 20 per cent on 1, 2, and
3 incomes
4 per cent on deferred
incomes
U. Pac. 15

It thus appears that the assessments varied from $7.20 on the East
Tennessee to $20 on Reading common, with less sums on the preferred
stock and the junior securities.[698] The real sacrifice demanded of
the stockholders is ascertained by deducting from the above the value
of securities given for assessments whenever such were allowed. Taking
for the purpose the market quotations of these securities six months
after actual reorganization, that is, after the sale of the road, or
the putting into effect of the plan proposed, it appears that the
common stock of the Atchison received $1.90; that of the Baltimore &
Ohio $15.20; that of the Richmond Terminal $5.02; that of the East
Tennessee $3.55; and that of the Union Pacific $8.10. The Erie, the
Northern Pacific, and the Reading gave nothing for assessments in
the nineties.[699] Preferred stock, whenever assessed, received the
same relative amount and kind of securities for assessment as did the
common stock, and the same is true of the junior securities. Since,
however, these new securities had but a prospective value at the time
of the issue of the various reorganization plans, it is advisable to
make no attempt to determine precisely the net assessment, and to call
attention to their allowance merely as a fact on which the stockholders
could rely as they could count on a future rise in the value of their
shares. With this qualification the relative height of assessments and
stock quotations one month after the publication of each reorganization
plan, and six months after the completion of each reorganization may be
given.

_Six Reorganizations, 1893–8_

_Common Stock_ _Preferred Stock_

_Price _Price
_Price 6 months _Price 6 months
1 month after 1 month after
_Assess- after reorgan- _Assess- after reorgan-
ments_ plan_ ization ments_ plan_ ization_

Atchison $10 $ 5¾ $13⅛
B. & O. 20 12⅜ 56¾ $20 $114
Erie 12 8½ 14⅛ 8 $22 36⅛
N. Pac. 15 1½ 13¼ 10 10 26¼
Reading 20 2½ 22¼
Richm. Term. 10 2⅞ 11⅜
E. Tenn. 7.20 ½ 6⅕ 3 10 13¼
U. Pac. 15 10⅛ 20

_Four Reorganizations before 1893_

E. Tenn., ’86 6 2½ 5⅘
Erie, ’59 2½ 2½
Erie, ’77 4 18½ 2 29
Reading, ’86 10 38⅜ 58 10 53¼[700]

In every case during the nineties the amount of assessment exceeded the
sum for which common shareholders could have sold their stock one month
after the publication of the reorganization plan. The difference ranged
from $3.50 for the Erie to $17⅔ for the Reading; in other words the
assessments wiped out the whole value remaining to common stockholders,
and exacted an additional contribution as the price of participation
in any future prosperity. In the case of the preferred stock, where
values were greater and assessments less heavy, the results were not
the same; but even here the proportional demand was large, and amounted
to 100 per cent of current quotations in the case of the Northern
Pacific. Before 1893 assessments were fewer in number and not so great
in amount. It is to the subsequent rise in stock quotations to which
we must turn for an explanation of the willingness of stockholders to
contribute such heavy sums. The assessments, we find, did not come
out of the stockholders’ pockets in the end; for their payment, in
connection with other features of reorganization, so enhanced the value
of shares that only six months after reorganization the price of stocks
in all cases was nearly equal to the assessment plus the previous
market quotation. In some instances, such as the Baltimore & Ohio,
the sum amounted to much more than this total.[701] Refusal to pay
would have wiped out the stockholder’s interest and have kept him from
benefiting from the rise. It is needless to add that quotations to-day
are many times the amount of the assessments. The increase in value has
occurred alike for common and preferred stock, even in times of severe
depression. On the whole, it has abundantly justified the payments
which stockholders were asked to make.

The use of assessments alone represents the most radical and the
soundest method of raising cash. It disposes of the accumulated quick
liabilities once and for all; and involves no subsequent increase
in interest charges. It was the method of the Atchison and the Union
Pacific after 1893, of the Reading from 1883–6, and of the Erie from
1875–7. It was furthermore the method of the Western, New York &
Pennsylvania in 1893,[702] of the Norfolk & Western in 1896,[703] and
of other railroads which might be named. Probably its most drastic
application was in the case of the Houston & Texas Central in 1887,
where an assessment of 73 per cent was found necessary to discharge the
floating debt and to provide cash payments for interest and bonus to
first mortgage bondholders, and to pay the charges, expenses, and other
liabilities made or incurred by the Trust Company.[704]

The sale of securities also has been relied upon for the production
of cash. The most striking example of the use of securities alone is
afforded by the Reading reorganization of 1883, which at the same
time illustrates the possible unsoundness of the method. The floating
debt of the Reading companies amounted in June, 1880, to $12,155,248,
the bulk having been incurred in attempts to maintain solvency. To
cover this Mr. Gowen proposed an issue of $34,300,000 deferred income
bonds,[705] to be sold at 30 per cent of their par value, and to be
entitled to dividends after 6 per cent had been paid on the common
stock. These securities were practically worthless, and had to be set
aside in favor, first, of new general mortgage bonds, and then of old
unissued general mortgage 7 per cent bonds which the company happened
to have in its treasury. So ineffective was even this expedient that
in October, 1884, the floating debt amounted to a sum nearly one-third
greater than that reported in 1880. Another example was the Erie scheme
of 1886, which was not, however, a reorganization, according to our
definition. The floating debt of the Erie in September, 1884, amounted
to $5,455,338, of which $1,007,922 consisted of unpaid coupons. On the
suggestion of English securityholders these coupons were funded; and
the balance was raised by a new terminal mortgage issued and disposed
of by a subsidiary terminal corporation known as the Long Dock Company.
The result was an increase in fixed charges, which contributed to the
final failure in 1893. The history of the Southern Railway affords a
third example. At the end of 1888 the Richmond & West Point Terminal
Railway & Warehouse Company found itself with a floating debt of
$5,000,000, and proceeded to authorize an issue of $24,300,000 5 per
cent 25-year collateral trust bonds, of which $5,000,000 were to be
sold to cancel this indebtedness. In subsequent years the current
liabilities again increased, and for this and other reasons a general
reorganization became necessary, in which both an assessment and a sale
of securities were required. On the whole the result of experience
bears out the statement as to the unsoundness of reliance on the
issue of securities for cash even when the sale of the securities is
guaranteed.

Yet another method of raising cash has been the combination of
assessments with the sale of bonds or stock or both. In 1898 the
Baltimore & Ohio disposed of $3,800,000 Western Union Telegraph stock.
It also provided a total of $37,900,000 prior lien and first mortgage
bonds and preferred stock, which was in part given for assessments,
and in part turned over to a syndicate in return for cash. The Erie,
in 1895, besides its assessment sold $15,000,000 in prior lien bonds;
while the Reading sold $4,000,000 in new general mortgage bonds and
$8,000,000 in new first preferred stock. In each case the success of
the sale was ensured by a syndicate agreement. In 1886, to go outside
of the reorganizations which have been particularly described, the
Texas & Pacific provided funds with which to cancel a part of its
floating debt by an assessment of $10 and an issue of $6,500,000 common
stock. Three years later, the St. Louis, Arkansas & Texas assessed its
second mortgage bondholders 5 per cent and its stock 10 per cent and
sold securities to the par value of $4,490,880 to cover $3,400,000
of cash requirements.[706] In 1894 the New York & New England issued
$4,355,000 in securities and levied $20 and $25 respectively upon its
common and preferred shares.[707] In 1896 the St. Louis & San Francisco
planned to raise $821,410 by assessment and $5,500,000 by sale of
securities. Such examples might be multiplied indefinitely.[708]

The problem of cash requirements must be met and solved before the
parties interested can consider the fixed charges. It is the reduction
in charges, nevertheless, which is usually of the more fundamental
importance. A floating debt accumulated through inability to pay
current expenses is the direct result of excessive charges, and a
settlement which did not lower these, as well as pay off the debt,
could give but temporary relief. Only when failure has been due to
special causes can a decrease in the annual burden be even a matter for
debate. The following tables show the absolute changes brought about
by those of the reorganizations earlier considered for which precise
figures are available:

FIXED CHARGES

_Seven Reorganizations, 1893–8_

_Per cent _Per cent
_Road_ _Before_ _After_ decrease_ increase_

Atchison $9,423,160 $6,486,842 31.16
B.& O. 7,202,855 6,359,896 11.70
Erie 8,637,700 8,126,283 5.92
N. Pac. 13,813,945 6,761,960 51.04
Reading 11,422,054 9,043,944[709] 20.81
Richm. Term. 7,498,584 4,195,925 44.04
system
U. Pac. 7,985,921 4,502,134 43.62
———– ———– —–
$65,984,219 $45,576,984 30.92

_Seven Reorganizations before 1893_

Atchison, ’89 $11,157,770 $7,256,054 34.9
Atchison, ’92 7,189,199 9,423,160 31.0
E. Tenn. ’86 1,742,495 1,167,000 33.0
Erie, ’75 4,697,802 5,215,146 11.0
Reading, ’80 7,734,031 11,535,078 49.1
Reading, ’83 8,235,047 7,581,032 7.9
Rk. I. ’80 1,508,989 1,271,836 16.3
———– ———– —- —
$43,276,372 $43,449,306 .53

_One Reorganization, 1902_

Rk. I. ’02 $4,780,649 $10,485,882 119.3[710]

From these tables, it appears that each of the reorganizations from
1893–8 occasioned an absolute reduction in fixed charges which varied
from 5.92 per cent in the case of the Erie to 51.04 per cent in that
of the Northern Pacific. On the other hand the reductions in the
earlier reorganizations were more irregular and were exceeded by the
increases.[711] Absolute figures, however, reveal little. Charges may
be reduced and the road be worse off than before because of more than
proportional reductions in mileage or in earnings. The preceding table
must therefore be supplemented by one showing the changes in charges
per mile of road and changes in the relations of charges to earnings.

FIXED CHARGES

_Seven Reorganizations, 1893–8_

_Charges per mile_ _Per cent of charges to net income_
_Before_ _After_ _Before_ _After_

Atchison $1415 $1001 110.5 80.9
B.& O. 3438 3107 98.2 86.3
Erie 4116 3824 114.7 95.8
N. Pac. 2630 1494 106.8 50.2
Reading 9856 6611 111.3 82.1
Southern 1553 955 105.1 81.5
U. Pac. 4381 1859 105.7 40.6

_Seven Reorganizations before 1893_

Atchison, ’89 $1603 $1064
Atchison, ’92 1079 1415 85.8 110.5
E. Tenn. ’86 1578 1083 134.3 79.5
Erie, ’75 4984 5619 93.9 91.1
Reading, ’80 9138 7287 98.1 83.0
Reading, ’83 8760 7185 78.3 77.0
Rk. I., ’80 1200 952 13.2 10.2

_One Reorganization, 1902_

Rk. I. ’02 1231 1448 39.8 59.0[712]

A summary of the preceding tables is as follows:

KEY: _A_: _Absolute Charges_
_I_: _Charges to Income_
_M_: _Charges per mile_

FIXED CHARGES BEFORE AND AFTER REORGANIZATION

_Seven Reorganizations, 1893–8_

_Per cent Decrease_ _Per cent Increase_
_A_ _I_ _M_ _A_ _I_ _M_

Atchison 31.1 26.7 29.2
B. & O. 11.7 12.1 9.6
Erie 5.9 16.4 7.0
N. Pac. 51.0 53.0 43.0
Reading 20.8 26.2 32.9
Southern 44.0 22.4 37.7
U. Pac. 43.6 61.5 57.5
—- —- —-
30.9 31.2 31.2

_Seven Reorganizations before 1893_

Atchison, ’89 34.9 33.6
Atchison, ’92 31.0 28.5 31.1
E. Tenn. ’86 33.0 40.8 31.3
Erie, ’75 2.9 11.0 12.7
Reading, ’80 15.3 20.2 49.1
Reading, ’83 7.9 2.2 17.9
Rk. I. ’80 16.3 22.7 20.6
—- —- —- —– —- —-
10.3 13.1 .53

_One Reorganization, 1902_

Rk. I. ’02 119.3 48.2 17.6[713]

These tables show plainly that substantial reduction in fixed charges
was the rule in the reorganizations of 1893–8, though less universal
and less important in the reorganizations before that date. Even before
1893, however, the fact that reductions must be made was apparent.
Three reorganizations increased absolute charges instead of decreasing
them. Of these the Atchison reorganization of 1892 was not due to
lack of prosperity, and the Erie reorganization was a failure. The
Reading reorganization of 1880 increased absolute charges, increased
mileage more than correspondingly, but was also a failure. And it is
significant that only those roads which generously reduced charges
regained even a temporary prosperity.

The distribution of losses which a reduction in fixed charges requires
can best be made by a comprehensive redistribution of securities. All
the bonds and stocks which are to suffer must be called in; and varying
amounts of new securities must be given in their place. Among the
important considerations to those who fix the rates for exchanges are
these:

(1) Maximum charges under the new régime should approximate minimum net
earnings under the old.

(2) As large a proportion of the charges as possible should consist of
the one item of interest on bonds.

(3) Losses should fall most heavily on the junior securityholders.

(4) The nominal value of outstanding securities should be reduced as
little as possible.

(5) Bondholders whose claims have been cut down should be afforded some
chance to participate in future increased earnings of the property.

These rules may be considered in turn. The point to which the best
practice should reduce fixed charges is readily understood. Nothing
less than solvency under the least favorable conditions is the
goal toward which a reorganization plan should strive. It appears,
accordingly, that the minimum earnings of the Atchison property from
1891–4 had been $5,204,880; while the fixed charges proposed for it
were $4,528,547. The lowest net earnings which the Union Pacific had
ever recorded had been $4,315,077. The interest on its new bonded
indebtedness was placed at $4,000,000. The net earnings for the
Northern Pacific in 1895 were $6,052,660, which was the least that the
road had earned for eight years. The new fixed charges were estimated
at $6,015,846. The minimum net earnings of the Baltimore & Ohio from
1887 to 1898 had been $6,610,774. The fixed charges of the plan of 1898
were set at $6,252,351.

In order to simplify the charges, as well as for other reasons, it
is desirable to have the item of interest bear a large proportion to
the whole. The fixed charges of six of our seven reorganizations from
1893–8 amounted together to $54,562,165. Of this sum, interest on bonds
comprised $35,239,146 or some 64 per cent. The charges of the same
railroads after reorganization amounted to $36,533,040, of which sum
interest on bonds comprised $30,926,638 or 84 per cent.

The distribution of losses should bear most heavily on the junior
securities. The simplest readjustment would seem at first sight
to demand a proportionate concession from all creditors. But this
would be both unjust and impossible. In no sense do all bond- and
stockholders stand upon an equal footing. In the first place, the
cost at which senior bondholders have acquired their claims has much
exceeded the cost at which junior bondholders and stockholders have
acquired securities of equal nominal amount. Apparently equal claims
represent very unequal investment. In the second place this increased
cost has been due to certain legal provisions touching security which
become prominent during reorganization. All mortgage bonds possess
by law a lien upon the property pledged to secure them. Upon default
in repayment of principal, and usually also upon default in payment
of regular interest, their owners have the right to sell the pledged
property at auction and to recoup themselves from the proceeds. After
the underlying bonds have been satisfied the selling price is applied
as far as it will go to the settlement in full of mortgages in the
order of their issue; while the stock, representing the owners of the
property, takes what is left. As a rule a railroad will not sell for
anything like the sum required to pay off all its mortgages, and the
junior issues are threatened with extinction. Usually, however, it is
possible for the junior to guarantee interest on the senior bonds, or
to buy the railroad at foreclosure sale under some senior mortgage,
thus preserving to themselves the benefit of the earning power of the
corporation. When this is done earnings are distributed according to
the relative priority of the various junior issues on penalty of still
further foreclosure and readjustment. The principle of reorganization
which is followed prescribes because of this the payment in full of all
claims which can be satisfied by the purchase price of the bankrupt
railroad at foreclosure sale, and the distribution of losses among the
remainder according to the relative priority of their liens.

The consent of securityholders to a reduction in their claim to an
annual return is more easily obtained if the nominal value of their
holdings be little or not at all reduced. There is a magic in the par
value stamped upon a certificate which affords a certain consolation
to those from whom sacrifices in interest are demanded. An unimpaired
principal, moreover, constitutes a real advantage when the date of
maturity arrives. But if the low earning power of the corporation
compels it to ask sacrifices from the holders of its securities, it is
only fair that these sacrifices should cease when the earning power
improves. In other words, it is but just that old bondholders be given
securities upon which payment of interest is optional, so that they may
share in future prosperity, and obtain the same return which they once
enjoyed whenever the road earns enough to pay it.

The foregoing rules dictate the amount of reduction to be made in
charges, and also the kind and amount of new securities which are
usually offered in the exchanges. Interest and rentals must be cut down
without decreasing the nominal value of the securities outstanding. To
reduce interest without reducing nominal value, either the interest
rate on outstanding securities must be lowered, or mortgage bonds must
be replaced by income bonds or by stock. To reduce rentals annual
payments may be arbitrarily cut down, or rental contracts may be funded
into mortgage bonds. These different methods may be taken up in some
detail.

The accompanying tables (see opposite page) show for fourteen
reorganizations the number and amounts of outstanding issues before and
after reorganization at the various rates of interest designated.

Few collections of figures in railway finance deserve more careful
attention than those given in these tables. Whereas the greatest number
of the issues before the seven reorganizations prior to 1893 bore 6 per
cent, and the greatest amount outstanding was similarly at that rate;
the overwhelming preponderance in amount after the reorganizations of
1893–8 bore 4 per cent, and a total of 14.7 per cent of all the bonds
outstanding bore a lower rate of interest than had appeared at all at
the earlier date.

BOND ISSUES

_Seven Reorganizations, 1893–8_

_Before_ _After_
_Per- _Per- _Per-
Cent_ _Number_ _Amount_ Cent_ _Number_ _Amount_ Cent_

7 33 $56,741,222 6.1 13 $43,942,500 4.9
6 85 300,925,695 32.7 30 82,586,000 9.3
5 51 267,623,426 29.0 23 90,853,035 10.3
4½ 11 34,490,800 3.7 5 13,400,000 1.5
4 9 260,055,689 28.2 16 520,709,117 59.0
3½ 2 76,733,350 8.7
3 1 53,350,000 6.0
— ———— —- — ———— —-
189 $919,836,832 99.7 90 $881,574,002 99.7
Not specified 5,141,238 1,000,529
———— ————
$924,978,070 $882,574,531

_Seven Reorganizations before 1893_

7 40 $153,251,000 23.7 21 $81,327,544 10.3
6 59 173,641,790 26.8 55 150,999,589 19.1
5 22 174,060,032 26.9 16 180,341,768 22.8
4½ 2 4,611,000 .7 1 79,000 .01
4 5 140,041,700 21.6 5 375,881,614 47.6
— ———— —- — ———— —-
128 $645,605,522 99.7 98 $788,629,515 99.81
Not specified 5,712,749 8,940,939
———— ————
$651,318,271 $797,570,454

Graphically indicated the change was as follows:

[Illustration: Period prior to 1893]

[Illustration: Period of 1893–8.]

Comparing the total interest with the total bond issue, we find the
average rate to have decreased from 5.5 per cent to 4.9 per cent by
the reorganizations prior to 1893, and from 5.1 per cent to 4.3 per
cent by the reorganizations of 1893–8. Of some significance is a
comparison of the rates prior to the reorganizations before 1893 with
those subsequent to the reorganizations of 1893–8. The total interest
payable on the issues at the later date was $38,291,319. If the same
proportions of bonds had been issued at the same rates of interest as
before the reorganizations prior to 1893, this interest would have
amounted to $48,552,688. The total interest payable on the issues
before the reorganizations prior to 1893 was $35,658,192. If the same
proportions of bonds had been then outstanding at the same rates as
after the reorganizations of 1893–8 the interest charge would have been
$27,941,807. Thus in the first case there would have been a saving of
$10,261,369 annually, and in the second case one of $8,279,775. This
computation is inexact because it fails to take account of the normal
reduction of interest rates due to improved credit and to increased
prosperity from causes other than reorganization; but it is included
here because, in the first place, a large part of the reduction was due
to actual reorganization; and in the second place, because much of the
improved credit is attributable indirectly to reductions of charges and
other reorganization features.

It should be noticed that the new bond issues not only bore lower rates
of interest, but were of greater volume and of longer term than the
issues which they replaced. The greater volume is reflected in the
considerable reduction in the number of issues at the same time that
the total amount of bonds outstanding decreased slightly or increased.
Thus the reorganizations before 1893 increased the amount of bond
issues from $645,605,522 to $788,629,515, and decreased their number
from 128 to 98; while the reorganizations of 1893–8 decreased the
amount of bonds from $919,836,832 to $881,574,002, and decreased the
number of issues from 189 to 90, or in far greater proportion.[714]
The matter may be viewed in another way. Just before the beginning of
the later reorganizations the predominant rate of interest for the
roads concerned was 6 per cent. The number of issues at 6 per cent
outstanding was 85 and the average amount per issue was $3,540,302. The
predominant rate just after those reorganizations was 4 per cent. The
number of issues at 4 per cent outstanding was 16, and the average
amount per issue was $32,544,319. In other words, the process was to
replace numerous small issues which bore high rates of interest, by a
few comprehensive issues at lower rates; thus simplifying the financial
situation, as well as lightening the burdens which the roads had to
bear.

The lengthening of the terms for which the various mortgages were
to run is equally apparent. Before its reorganization in 1897 the
Union Pacific had no mortgage issued for more than 40 years. The
first mortgage of 1897 ran for 50 years. The Reading in 1895 had four
mortgages, all issued during the reorganization of 1888, with terms of
70 years. All its other mortgages were for shorter periods. In 1897 it
put forth a grand divisional mortgage with a term of 100 years. The
Erie in 1894 had two mortgages of 91 years each and one of 84 years,
issued during the financial scandals of 1869, but no other of over
$1,000,000 which ran for more than 43 years. Both its prior lien and
its general mortgage bonds now outstanding are to mature 101 years from
date of issue. The Atchison in 1889 could boast of only one mortgage
with a term of 51 years. Its reorganization at that time gave it two
of 100 years. The Northern Pacific issued one 100-year mortgage in the
course of its troubles in 1889, and two mortgages for 101 and 150 years
respectively in its reorganization of 1896. The reason for long terms
has been the wish to make new mortgages attractive. Reorganization
mortgages, as has just been said, tend to be large mortgages, at a
lessened rate of interest. They are also blanket mortgages with an
inferior lien. Some inducement besides the compulsion of necessity
is useful in securing the assent of old bondholders to the proposed
exchanges of these bonds for outstanding securities. The long-term bond
protects the holder against the probable steady fall in the rate of
interest on capital. It promises him advantage in the future in return
for surrender in the present.

The reduction in charges by the substitution, for mortgage bonds
with fixed interest, of securities upon which payment of interest
is optional, has been as important as the reduction in the rates of
interest just described. Such securities may be either income bonds
or stock. The income bond has a lien upon railroad property similar
in kind to the lien of an ordinary mortgage. Upon default in the
payment of its principal it can exercise foreclosure rights. But it
has no claim on earnings except in a right to receive dividends out of
net earnings before any dividend shall be paid upon the stock. Stock
certificates control the company by their right to vote,[715] but are
entitled to its profits only after expenses of every kind have been
met. When divided into preferred and common shares the former receive
preference in dividends and sometimes in voting power. Among the
reorganizations described in the text three made use of income bonds
before 1893 and one after 1893. The amounts of the issues and the
percentages of incomes to total capitalization before and after the
reorganizations were as follows:

_Income Bonds_

_Per cent_
_Before_ _After_ _Before_ _After_

Atchison, ’95 $51,728,000 31.8
Atchison, ’89 80,000,000 35.4
Reading, ’83 $22,347,227 56,389,466 21.7 39.3
Reading, ’80 11,678,500 18,737,709 15.0 19.3

The East Tennessee reorganization of 1886 did away with income bonds,
as did that of the Atchison in 1892. It will be noted that these bonds
were more used before 1893, owing probably to the fact that the name
of bond was considered to increase the salability of a security on the
market. Securityholders hesitated to accept stock, but received bonds
without too great a protest. The extent to which railroads catered to
this preference is seen in the case of the Reading deferred income
bonds, on which payment of interest was deferred to a 6 per cent
dividend upon the common stock. From certain points of view, however,
the income bond is inferior to preferred stock. For instance, preferred
stock almost always has voting power, while income bonds usually have
none. And although the income bondholder is sometimes protected from
the insertion of new claims upon earnings between his bond and the
underlying property, provisions in preferred stock certificates may
afford an equal guarantee. In consequence, the use of income bonds has
declined as a more accurate knowledge of their limitations has become
widespread, and the Atchison adjustment 4s represent the sole use of
this security in our reorganizations from 1893–8.

The exchange of preferred stock, with or without new bonds, for old
bonds which have borne a fixed interest rate represents the best
current practice. Six of the seven principal railways reorganized from
1893–8 retired old bonds with fixed interest by new bonds and preferred
stock or by preferred stock alone. Take for illustration the case of
the Erie, which exchanged new general lien bonds and preferred stock
for old second consolidated bonds; of the Northern Pacific, which
exchanged new prior or general lien bonds and preferred stock for its
second and third mortgages; of the Union Pacific, which gave 4 per cent
bonds and preferred stock for its old first mortgage 6s; exchanges
which are but typical of a widely extended use. Even the Reading, which
alone refused so to lighten the claims upon its earnings, employed
preferred stock in retirement of old first, second, and third income
bonds.

These issues were all protected from future introduction of new bonds
between them and their property. The preferred stock certificates of
the Atchison in 1897 contain the following words: “No mortgage, other
than its general and its adjustment mortgage, executed in December,
1895, shall be executed by the company, nor shall the amount of the
preferred stock be increased unless the execution of such mortgage and
such increase of preferred stock shall have received the consent of
the holders of a majority of the whole amount of the preferred stock
which shall at the time be outstanding, given at a meeting of the
stockholders called for that purpose, and the consent of the holders
of a majority of such part of the common stock as shall be represented
at that meeting.” Similar restrictions were imposed by the Southern
in 1893, by the Erie in 1895, by the Northern Pacific in 1896, by the
Reading in 1896, and by the Baltimore & Ohio in 1898; or in other words
by all the large corporations except the Union Pacific, whose failures
in the nineties we have described.

As for the years before 1893, in them the use of preferred stock
was known, if not so widely resorted to. The East Tennessee in 1886
offered new consols and preferred stock for old consols, divisional
and debenture bonds. In 1881 securityholders of the Reading proposed,
and in 1886 nearly secured, the adoption of plans which comprised
extensive issues of preferred stock in exchange or in partial exchange
for old mortgages. The influence of English capital, however, and the
liking for the name of bond to which we have referred seems to have
prevented large employment of the device. Where either preferred stock
or income bonds were used protection was afforded. When, in 1875, all
the outstanding bonds of the Northern Pacific were replaced by stock,
provision was made for an issue of first mortgage bonds to an average
of $25,000 per mile of road completed; but no other bonds were to be
issued except on a vote of at least three-fourths of the preferred
stock at a meeting specially held in reference thereto on thirty days’
notice. In the Reading reorganization of 1886 a clause provided that
in calculating the net earnings from which dividends on income bonds
should be paid there should be deducted from gross profits operating
expenses, taxes and existing rentals, guarantees and interest charges,
but not fixed charges of the same sort subsequently created. And in
the case of the Atchison in 1889 the provision that no bonds could
be inserted between the incomes and the general mortgage 4s was so
absolute as to prove an almost complete bar to new issues.

It is this use of preferred stock and income bonds which makes it
possible to realize the last and highly important rule which the
engineers of exchanges have in mind. Only by the combined use of
securities upon which payment of interest is optional with securities
upon which payment is obligatory can the claims which their
corporations are forced to meet be reduced, while at the same time
former bondholders are given the chance to share in future prosperity.
Such a result is deliberately sought. “The general theory of adjustment
of disturbed bonds,” said the Richmond Terminal reorganization plan of
May, 1893, “has been to substitute for them the new 5 per cent bonds
to such an extent as is warranted by the earnings and situation of the
properties covered by the present mortgages, and the new preferred
stock for the remainder of the principal.” This purpose receives,
moreover, a natural development. Justice does not demand that old
bondholders be given the unlimited chance at future surpluses which
old stockholders should enjoy. Their former holdings could expect
but a fixed amount, and the maximum to be paid on their new bonds
and preferred stock is therefore rightly restricted. But fair play
dictates that they be given opportunity to receive the _same_ income
as before. If they must surrender 6 per cent bonds in exchange for 4
per cent bonds it is equitable to allow to them as well 50 per cent
of their original holdings in new 4 per cent preferred stock. The
corporation thus announces its intention of saving them unharmed if it
can possibly do so, while it insists that its solvency be not dependent
on the success of its attempt. This idea has been realized in a number
of cases with approximate exactness. The old third mortgage 6 per cent
bonds of the Northern Pacific in 1896 received 118½ per cent in new 3
per cents, 50 per cent in 4 per cent preferred stock, and 3 per cent in
cash,—which together could yield nearly the same as the old mortgage.
The holders of Chicago Division 5s of the Baltimore & Ohio in 1898
surrendered an annual income of $50 for a chance to receive $50.30;
the Union Pacific first mortgage 6s in 1898 obtained precisely 100 per
cent in new 4 per cent bonds and 50 per cent in new 4 per cent stock.
It would be too much to expect that such exactness should generally
obtain. The variations in security between issues, the well-founded
desire to distinguish and not at the same time to swell unduly the
amount of new stock put forth lead to fluctuations both above and
below the point of equivalence of return. The important fact to
remember is in short this: that the use of bonds with a fixed rate of
interest, together with bonds or stock upon which payment of interest
is optional, provides that compromise between the interests of the old
bondholders and the interests of the corporation which alone can afford
justice to both sides and can allow the reorganization to proceed.

The matter of rentals may now be considered. “The extent of the
reduction in rentals from reorganization,” says one authority,[716] “is
seen where the reduction of this item of fixed charges for the entire
country is considered. The net reduction in lease rentals from 1892 to
1898 was $24,527,000, and of this sum $17,768,000 appears in the South
and West where the failures where most numerous and extensive. The
reductions of rentals are most conspicuous in the Northwest and Pacific
coast railroads. It is true that a part of this decrease in rentals is
to be ascribed to the steady movement in the direction of consolidation
which is constantly converting lease into purchase; but coming so
close together, the difference between the figures of 1892 and those of
1898 is sufficiently marked to warrant the conclusion that most of the
reduction is due to the numerous reorganizations which intervened.”

This conclusion is at first sight borne out by the following tables,
which show the decreases or increases in absolute rentals and interest
for thirteen reorganizations, of which six fall within the period
covered by the quotation:

KEY: _D_: _Decrease_
_I_: _Increase_
FIXED CHARGES

_Six Reorganizations, 1893–8_

_Interest_ _Rentals, etc._ _Total Charges_
_D_ _I_ _D_ _I_ _D_ _I_

Atchison 40.6 13.7 31.1
B. & O. 19.7 77.2 11.7
Erie 33.3 62.7 5.9
N. Pac. 14.2 88.9 51.0
Reading 20.8
U. Pac. 21.8 78.2 43.7
Average —- —- —-
decrease 4.7 58.8 25.7

_Six Reorganizations before 1893_

Atchison, ’89 39.0 17.3 34.9
Atchison, ’92 38.7 3.9 31.0
Erie, ’75 13.4 .5 11.0
Reading, ’80 15.9 98.1 49.1
Reading, ’83 13.3 .6 7.9
Rk. I., ’80 11.9 25.2 16.3
Average —- —- —- —- —- —-
decrease 1.0 9.9 5.3

_One Reorganization, 1902_

Rk. I. ’02 139.0 29.0 119.3[717]

It appears that while the decrease in rentals was of little importance
in the six reorganizations before 1893, it was of great importance
in the reorganizations from 1893 to 1898. Whereas absolute interest
charges were reduced by none of the later reorganizations by over 40
per cent, four of the railroads cut rentals by over 60 per cent, and
two others might have shown a similar result if a satisfactory division
between interest and rentals could have been made. Unfortunately, both
these statistics and Meade’s statement are open to criticism for the
reason which Meade recognized but to which he did not give sufficient
weight. The relative amounts of interest and of rental paid by a
railroad at any time represent the method by which its system is held
together. If a parent company raises money by the sale of bonds, and
purchases its branches outright, or buys a majority of their shares,
its interest charges will be large and its rentals small; if it leases
these same lines its interest payments will be small and its rentals
large. A steady movement in the direction of consolidation doubtless
existed before 1893, but this movement was certainly accelerated by,
and made a prominent feature of many of the reorganizations of the
following five years. Thus the Northern Pacific in 1893 reported a
total length of line of 5431.92 miles; of which leased lines and
lines operated under contract constituted 1912.92. In 1898, after
reorganization and surrender of the Wisconsin Central, it reported
4524.45 miles owned and operated, of which 2430.42 consisted of main
line, and 2030.82 of branch lines owned. The Erie in 1893 reported
551.12 miles leased and 598.51 operated for 32 per cent out of a total
of 1970.32.[718] Four years later it either owned outright or held a
majority of the stock of 1806.92 miles out of a total of 2162.81. The
Baltimore & Ohio operated 26.5 per cent of its mileage in 1897 under
lease or contract, but had reduced this by 1899 to .5 per cent. The
Southern Railway proportion was 38.1 per cent in 1892 and 28.4 per cent
in 1895. A reduction in rentals through reorganization has occurred,
but a reduction due nevertheless largely to consolidation of systems,
rather than to revision of rental contracts.

It was partly because of the difficulty of exact statement on the
subject that a discussion of rentals was postponed till the matter of
interest should have been considered. It now appears that the reduction
in interest payments which was so prominent took place in spite of a
reduction in rentals. If, for instance, the annual interest charges
fell $10,261,369 in the course of all reorganizations, and if in later
years the interest figures represented charges which at earlier date
appeared as rentals, then the real reduction in interest was greater
than the figures show. It is true that consolidation is not responsible
for all of that decline in rentals which has occurred. It is as open to
a reorganizing railroad to continue old leases at easier terms as it is
to absorb the leased roads into its system; and much of this has been
done. The East Tennessee, Virginia & Georgia, for instance, leased the
Memphis & Charleston in 1877 for a yearly payment of $297,750; while
the Southern Railway Security Company a few years before had agreed
to pay $318,763.50 annually for the same property. And it is a fact
that both consolidation and direct agreement have been the occasion of
considerable reductions in the payments for the control of subsidiary
lines. There is no reason why leased lines which have not earned their
rentals should not suffer as much as portions of the main system which
have not earned interest on their bonds. On the whole, then, rentals
have decreased, both by means of direct negotiation and through an
absorption of leased roads into the main system accomplished by
exchange of new securities for old. The significance of precise figures
must not be exaggerated. The losses which have occurred have been
distributed according to the same principles which have already been
detailed.

It is now clear that creditors, stockholders, and syndicate in
practically all successful reorganizations agree that cash must be
raised, fixed charges reduced, and the losses distributed according
to the seniority of existing claims; and that of all methods the
comprehensive exchange of new securities for old is best suited
to accomplish at least the last two of these necessities. To give
a comprehensive view of the operations the capitalization after
reorganization of the roads which have been studied may be compared
with the capitalization before. It will then be possible to see at
a glance the consequences of the great variety of exchanges. The
following table gives the percentages which the stock and bonds of
these companies bear before and after reorganization to the total
capitalization before.

KEY: _B_: _Bonds_
_P_: _Preferred Stock_
_C_: _Common Stock_
_T_: _Total_
CAPITALIZATION

_Seven Reorganizations, 1893–8_

_Before_ _After_
_B_ _P_ _C_ _T_ _B_ _P_ _C_ _T_

Atchison 69.2 30.7 100 48.9 39.6 30.7 119.2
B. & O. 72.9 4.5 22.5 100 121.3 35.4 31.6 188.3
Erie 58.4 4.1 37.4 100 59.0 22.1 48.1 129.2
N. Pac. 61.0 16.5 22.4 100 71.3 34.2 36.5 142.0
Reading 80.3 19.6 100 61.2 33.2 33.2 127.6
Southern 52.5 8.8 38.6 100 43.8 23.5 59.8 127.1
U. Pac. 40.9 27.3[719] 31.7 100 50.4 45.7 39.1 135.2
—- —- —- — —– —- —- —–
Average 65.8 4.6 29.5 100 59.1 33.6 39.2 132.0

_Seven Reorganizations before 1893_

Atchison, ’89 67.7 31.8 100 95.6 31.8 127.4
Atchison, ’92 68.8 31.1 100 70.2 31.1 101.3
E. Tenn. ’86 48.2 19.2 31.9 100 22.1 34.2 31.9 88.2
Erie, ’75 38.5 61.4 100 47.4 60.5 107.9
Reading, ’80 69.1 1.3 29.5 100 86.3 1.3 29.6 117.2
Reading, ’83 71.9 .4 27.6 100 100.4 27.6 137.7
Rk. I. ’80 32.2 67.7 100 40.3 135.4 175.7
—- —- —- — —– —- —- —–
62.5 1.7 35.7 100 73.9 2.8 37.6 114.4

_One Reorganization, 1902_

Rk. I. ’02 54.2 45.7 100 55.7 40.0 57.2 152.9

The most striking fact is that every reorganization but one has
occasioned an increase in total capitalization.[720] The increase
varies from 1.3 per cent for the Atchison in 1892 to 88.3 per cent for
the Baltimore & Ohio in 1898; and the average increase is 32 per cent
for the later period and 14.4 per cent for the earlier. This reflects
the exchange of new securities on which a lower rate of interest is
payable with securities on which all payments are optional, for old
securities which claim a high annual return. It is the result of the
attempt to reduce the demands upon reorganized corporations without
materially reducing the sums which old securityholders may in times of
prosperity receive. It reflects also, however, the sale of securities
for ready cash, or the exchange of these for assessments, as well as
the investment of minor sums in the improvement of the roads. A closer
examination of the table shows that the increase comes chiefly in
bonds before 1893 and in stock after that date. The average increase
in bonds of the seven reorganizations before 1893 was 11.4 per cent
and of common stock .9 per cent; whereas bonds decreased between the
reorganizations of 1893–8 from 65.8 per cent to 59.1 per cent of the
previous capitalization, although common stock increased 9.2 per cent
and there was introduced a great volume of preferred stock which is
scarcely found at all before. The less radical nature of the early
reorganizations and the use of income bonds instead of preferred
stock as a security with optional interest are here apparent. In
brief, the statement of capitalization before and after reorganization
summarizes and confirms the conclusions which we have reached. A few
fundamental principles have underlain the complicated details of the
exchanges of new securities for old. These principles appear when the
reorganizations are examined one by one, and they show not less clearly
when all the reorganizations are taken in two general groups.

Another question now naturally arises. If an increased capitalization
has been obtained without an increase in charges, owing to the lowering
of the rates of bond interest and to the liberal use of stocks or
income bonds, what has been the effect on the market value of the
securities concerned? Is the aggregate value of the new securities less
or greater than the aggregate value of the securities which they have
replaced? It has been seen that taken as a whole less annual payments
can be claimed from the railroads as of right. Has this fact decreased
aggregate quotations, or has the larger volume of securities and the
chance for dividends over and above the minimum interest, raised such
quotations higher than they were before? The following tables compare
the quotations of securities disturbed by the various reorganizations
one year before the failure of their railroads, with the quotations one
year after reorganization of the new securities issued to exchange
for them. A third column is inserted to show the effects of years of
prosperity upon quotations subsequent to reorganization.

_Seven Reorganizations, 1893–8_

_Lowest quotation _Lowest quotation
of month one of month one
year before year after _Lowest quotation
failure_ reorganization_ December, 1906_

Atchison $184,857,934 $129,364,451 $342,941,683
B. & O. 26,955,000 34,092,518 45,634,437
Erie 67,190,748 38,895,077 82,230,457
N. Pac. 157,555,214 135,507,699 289,557,415
Reading 88,940,250 71,607,223 179,190,107
Southern 45,653,414 35,231,356 71,411,937
U. Pac. 83,241,672 103,329,339 187,596,748
———— ———— ————–
$654,394,232 $548,027,663 $1,198,562,784
D. 16.2 per cent I. 83.1

_Four Reorganizations before 1893_

Atchison, ’89 $129,142,003 $113,993,417
Atchison, ’92 35,100,000 42,600,000
E. Tenn. ’86 17,657,377 21,746,188
Reading, ’83 39,061,531 48,664,864
———— ————
$220,860,911 $227,004,469
I. 2.7 per cent

It thus appears that the increased volume of securities of the
reorganizations of 1893–8 sold for a less aggregate price than did the
smaller volume which it replaced. Whereas the disturbed securities
of the seven roads in question, multiplied by their quotations
one year before reorganization, give a product of $654,394,232,
the new bonds and stock given for the disturbed securities,
multiplied by their quotations one year after reorganization, give
a product of $548,027,663.[721] This is not true for three of the
four reorganizations before 1893, and it is not true for the
reorganizations of the Baltimore & Ohio and of the Union Pacific in the
later period. Individual causes account for most of the difference.
The Reading reorganization of 1886–8 took place so soon after the
previous failure that our method makes it necessary to take the
quotations of securities “before reorganization” only five days after
the railroad has left receivers’ hands. These figures are therefore
unduly depressed. The Atchison reorganization of 1892 was voluntary,
and was not caused by financial difficulties. The reorganizations of
the Union Pacific and of the Reading in 1897 and 1898 respectively
occurred later than most of the other reorganizations and benefited
from the sharp increase in stock and bond quotations which began in
1897. For the seven reorganizations of 1893–8, to repeat, the aggregate
market value of old securities before reorganization was greater than
the market value after reorganization of the new securities given
in exchange for them. The smallest changes took place in the senior
securities. In the case of the Northern Pacific the aggregate value
of the three prior mortgages disturbed increased from $85,498,685 one
year before failure to $86,158,702 one year after foreclosure; while
the consolidated or blanket mortgage of the company decreased from
$36,032,360 to $29,235,111. In the case of the Reading the value of the
general mortgage 4s increased from $37,160,977 to $37,383,503, while
the first, second, and third income bonds decreased from $32,353,497 to
$22,784,700. The reason was not generally a smaller increase in volume,
but the fact that new bonds of fairly stable value were given for the
better sorts of old securities, while old junior mortgages were apt to
receive new income bonds or preferred stock, of which the value varied
within wide limits.

The wide difference in the nature of the securities of the different
roads forbids any attempt at precise classification. The following
divisions may, however, be made: Three of the reorganizations from
1893–8 retired branch-line bonds for which quotations are obtainable,
with a resultant increase in value for the issues of $3,256,127, or
14.2 per cent. Five of the reorganizations dealt with what may be
classed as general mortgage bonds, and the value of the new securities
given was to the value of the old as $182,160,406 to $196,186,382,
or a decrease of 7.1 per cent. Three of the reorganizations retired
junior bonds other than income. The value of the old securities
was $47,874,648 and that of the new $22,272,174, or a decrease of
53.6 per cent. Four of the reorganizations retired income bonds. The
value of the old securities was $40,913,662, the value of the new
was $28,177,721, and the decrease was 31.1 per cent. Three of the
reorganizations retired old preferred stock, and reduced the aggregate
market value from $36,509,662 to $13,825,138, or 62.1 per cent.
Finally, the common stock decreased 21.3 per cent from an aggregate
value of $125,160,409 to one of $98,316,060. Stated in tabular form the
result is as follows:

_Value one _Value one _Per Cent
year before year after increase
failure_ reorganization_ or decrease_

Branch-line bonds $22,840,928 $26,097,055 I. 14.2
General mortgages 196,186,382 182,160,406 D. 7.1
Junior mortgages 47,874,648 22,272,174 D. 53.6
Income mortgages 40,913,662 28,177,721 D. 31.1
Preferred stock 36,509,662 13,825,138 D. 62.1
Common stock 125,160,409 98,316,060 D. 21.3

This makes more definite the conclusion which has been outlined in
general terms before. The burden of the reorganizations from 1893–8
fell on the junior securities and stockholders. The holders of prior
lien bonds actually had more value than before one year only after
reorganization had taken place; the general mortgage bondholders had
nearly recouped their losses; while the former position of the other
creditors and of the stockholders was far from being regained.

It may be objected that the decreases in market quotations were due to
a general decline in prices of securities and not to reorganizations
of the roads in question. This objection, however, cannot hold. It is
true that a general decline began in the United States in February,
1893, and continued through 1894, reaching its lowest point in August,
1893, and, after that, in March, 1895; and that this decline was due to
general conditions of panic and depression. In 1895, however, a revival
took place, and, proceeding with uncertain steps through 1896, became
obvious and important in 1897 and 1898. The average date of failure
from 1893–8 of the seven roads described in the text was October 1,
1893, and the average date of reorganization was September 1, 1896.
Since the market price figures quoted are taken one year before failure
and one year after reorganization, conditions in October, 1892, should
be compared with those in September, 1897. The following diagram traces
the movements of twenty-six important railroad common stocks between
those dates. Quotations for none of the seven railroads in question are
included.[722]

[Illustration]

It is evident that the prices of the above stocks were not materially
lower on September 1, 1897, than on October 1, 1892. The exact average
was 73¾ for the earlier month, and 71⅛ for the later. The comparison
may fairly, however, be carried further than this, and considerable
pains have been taken to arrive at general figures which are
conclusive. Such, it is believed, are the following. The market value
of thirty-nine different bond issues of seventeen companies, taken
at random from among those frequently bought and sold upon the New
York and Philadelphia exchanges, was in October, 1892, $388,628,968.
This differed little from the market value of the same securities in
September, 1892, which was $388,198,432, or that in November, 1892,
which was $390,170,323. The market value of these issues in 1897 was
$371,125,135 in August, $373,875,293 in September, and $372,962,239 in
October. Represented in tabular form the situation appears as follows:

_Market Value of Securities_

1892 1897 _Decrease_

September $388,198,432 August $371,125,135 4.4 per cent
October 388,628,968 September 373,875,293 3.7 per cent
November 390,170,323 October 372,962,239 4.4 per cent

In other words, the quotations for this large mass of representative
securities were within 4½ per cent in 1897 of what they were in 1892.
If to these are now added the same proportions of stock that existed
for the disturbed securities of the seven reorganizations from 1893–8
there appears the following result:

_Market Value of Securities_

1892 1897 _Decrease_

September $641,105,160 August $620,794,202 3.1 per cent
October 644,276,634 September 631,061,329 2.0 per cent
November 644,131,632 October 629,005,577 2.3 per cent[723]

This is, as nearly as possible, a computation comparable with figures
already cited. It is made up the same way, has too broad a basis to
give a non-typical result, and is not dependent upon the selection
of a single month for its conclusion that security prices had nearly
regained their former level by the last half of 1897. A decrease
in value of 16.2 per cent for the securities of seven reorganized
railroads has been determined. Less than one-fifth of this can be
attributed to general causes. The significance of the decrease
therefore remains.

In conclusion, two other points of interest may be mentioned. First,
the provision which sound reorganization plans should make for the
future development of their properties, and second, the creation
of voting trusts to prevent sudden changes in control. It has been
seen that restrictions on new mortgages have accompanied the issue
of income bonds and of preferred stock, in order to afford to these
latter a desirable protection. If old bondholders demand these
clauses, a certain amount of new issues is required by the interests
of the corporation. A railroad is never finished. New extensions and
improvements which shall increase earnings are generally called for
to a degree which current earnings are insufficient to meet. Some
provision for regular increments of new capital, without the need of
stockholders’ approval in each case, is highly advisable, and implies
no lack of conservatism. In fact, some such provision is often forced
upon a railroad. Take the case of the successive reorganizations of
the Atchison properties. In 1889 no new bonds were to be allowed to
be inserted between the income and the mortgage issues, but it was
left optional with the management to deduct all improvements before
estimating the earnings applicable to dividends on the former bonds.
This proved quite inadequate, and the reorganization of 1892 provided
definitely a fund of $20,000,000 second mortgage bonds, which were to
be issued to a limit of $5,000,000 each year, for specific improvements
on the Atchison, exclusive of the Colorado Midland and the St. Louis
& San Francisco. The right was reserved to the company, when all
the above should have been used up, to issue more bonds of the same
sort for the same purpose, and on the same mileage up to a limit of
$50,000,000. Finally, in 1895, there were reserved $30,000,000 general
first mortgage bonds, to be issued each year to a limit of $3,000,000,
and $20,000,000 adjustment bonds, to be issued each year to a limit
of $2,000,000, after the general mortgage fund should have been
exhausted. In each of the reorganizations in the nineties considered
in this study, in which restrictions on new bond issues were imposed,
there was concomitant provision for regular increments of mortgage
bonds to be used for improvements, betterments, and new construction.
Thus the Baltimore & Ohio in 1898 reserved $5,000,000 prior liens
and $27,000,000 general mortgage bonds, of which the latter were to
be issued at the rate of not exceeding $1,500,000 for the first four
years after the organization of the new company, and not exceeding
$1,000,000 a year thereafter; and the former were to be put forth at
the rate of not exceeding $1,000,000 a year after January 1, 1892, for
enlargements, betterments, and extensions. The Erie in 1895 provided
$5,337,208 in cash to be spent at once, and $17,000,000 in general lien
bonds to be issued during the years following the reorganization. The
Northern Pacific in 1896 set aside $25,000,000 prior lien bonds, of
which not more than $1,500,000 were to be issued in any one year, and
$4,000,000 general lien bonds, presumably to be used as needed. The
Reading in 1895 reserved $20,000,000 general mortgage bonds for new
construction, additions, and betterments, of which not over $1,500,000
were to be used in any one year. And, finally, the Richmond Terminal
reserved $20,000,000 in 5 per cent bonds to be used at the rate of
$2,000,000 per year, and has recently authorized a $200,000,000 4 per
cent mortgage which will raise the yearly limit of expenditure to
$5,000,000.[724]

Before the nineties, as after, provision for new capital accompanied
restriction on the future issue of bonds. In 1886 the Reading provided
a lump sum of $9,792,000 general mortgage bonds for future use in
the improvement of the railroad; and in 1875 the Northern Pacific
contemplated the issue of first mortgage bonds to an average of $25,000
per mile of new road actually completed. Where, as with the Atchison in
1889, some such provision did not accompany the general restrictions
placed upon new bond issues, or where, as with the Northern Pacific in
1875, the provision proved inadequate, fresh measures of relief were
compelled. The Atchison reorganization of 1892 has been mentioned; in
1889 a financial operation of the Northern Pacific, which according to
our definition was not properly a reorganization, provided $20,000,000
5 per cent consolidated mortgage bonds for additional branches at a
rate not to exceed $30,000 per mile, and a like sum for betterments,
etc.

Even where no restrictions on future bond issues are imposed, it is
highly advisable that some provision for future capital requirements
be made, and that the management have at its disposal a fund of bonds
issuable without the approval of stockholders in each case. It is
probable, therefore, that some such provision would have been a feature
of some, at least, of the reorganizations even had the restrictions
described not made the clauses an imperative necessity; but if we may
judge from the rather restricted basis on which we are here at work,
the provisions would have been far less liberal than we have found to
be the case. In 1895 the Union Pacific set aside $13,000,000 4 per
cent bonds and $7,000,000 preferred stock to dispose of equipment
obligations, and for reorganization and corporate uses. Of these,
corporate uses were stated to be those which would be proper to the
corporation thereafter, such as the issue of securities in extension
of the property. This, of course, was quite inadequate. Similarly the
Rock Island in 1902 and the Erie in 1875–7 provided for a certain issue
of stock or bonds to be applied to future capital requirements. It is
undoubtedly true that both the Erie and the Reading railroads were
hampered by the lack of adequate provision of this nature; though as
the main difficulty of each corporation was the continued existence
of heavier charges than it could bear, an automatic increase of
indebtedness would not have proved a solution of their troubles.

The essence of a voting trust is the deposit of stock in the hands
of trustees (most frequently five in number). These trustees issue
certificates in return. All dividends declared on the stock are paid
over to holders of certificates, but all the voting power is exercised
by the trustees so long as the trust endures. Of the reorganizations
which we have described, ten reorganizations with foreclosure included
five voting trusts and one proxy committee; eight reorganizations
without foreclosure included two voting trusts; ten reorganizations
before 1893 included two voting trusts (though a third was proposed
for the Atchison in 1889); seven reorganizations in 1893–8 included
five voting trusts and one proxy committee. The use of voting trusts
has therefore become more general, denoting a realization of the
dangers of fluctuating and speculative control at critical periods in a
railroad’s history. This desire to secure conditions of stable control
has been the dominant one in the cases under consideration. “In order
to establish such control of the reorganized company for a series of
years,” said the reorganization plan of the Baltimore & Ohio in 1898,
“both classes of stock of the new company shall be vested in … five
voting trustees.” “The importance of vesting in the present creditor
class the management of the properties until their productiveness
is considerably increased … is manifest,” said the syndicate
reorganization plan of the Reading in 1886. It is of supreme importance
that a reorganized company be well started on its way by men who have
an interest in making the reorganization plan permanently successful,
and that conservative direction be assured until danger of bankruptcy
be past. For this reason we should expect the use of voting trusts to
increase in direct relation to the seriousness of the difficulties
experienced, and to the vividness with which the need for stability is
felt. If we may generalize, and say that a railroad which cannot be
reorganized without a foreclosure sale is usually in more desperate
straits than one which can be saved by voluntary concessions, we have
an explanation of the coincidence of foreclosures and voting trusts.
The teachings of experience, which have shown both the usefulness of
voting trusts as tools, and the necessity of a solution such as they
offer, further explain the increased prominence of the trust in later
years.

It is not true that voting trusts are always used for the purposes
indicated. In 1892 certain stockholders of the Baltimore & Ohio agreed
to deposit their certificates in a trust for one year and five months.
The stock deposited amounted to $8,975,000 out of a total outstanding
of $25,000,000, and a limit of $11,000,000 was set to the amount to be
so placed, the object of the arrangement apparently being to increase
the influence of the stockholders concerned by concentration of their
holdings.[725] Again, in 1895, to take an outside example, the stock
of the Oregon Railway & Navigation Company was placed in trust with
the Central Trust Company in order better to protect the preferred
stock. It was provided that during the continuance of the trust the
Central Trust Company should vote all the stock: first, against any
increase in the preferred stock unless the holders of all the voting
trust certificates of both classes should give their unanimous consent
at general meetings; second, against all propositions relating to the
mortgaging, selling, or leasing of the railroad and telegraph lines
of the company, or to the consolidation thereof, unless a majority
of each class of certificates should consent; third, on all other
questions as directed by the holders of a majority of the aggregate
of all voting trust certificates of both classes represented at
general meetings.[726] Further provisions gave to the preferred stock
control of a majority of the board of directors. These instances are
of interest; but the principal purpose of the voting trusts in the
reorganizations which we have considered has been nevertheless the
securing of stability of control for a definite period after the
rehabilitation of the bankrupt companies.

The duration of the voting trust varies from company to company. The
most usual provision is for five years. Frequently the voting trustees
may terminate the trust earlier at their discretion, as in the case
of the Baltimore & Ohio trust of 1898, the Richmond Terminal trust of
1894, or the Northern Pacific trust of 1896. Frequently, also, certain
conditions must be fulfilled before termination. In the case of the
Erie in 1895 no stock certificates were to be due or deliverable
before December 1, 1900, nor until the expiration of such further
period, if any, as should elapse before the Erie Railroad Company
in one year should have paid 4 per cent cash dividend on the first
preferred stock.[727] In the case of the Reading in 1896 4 per cent
cash dividends on the first preferred stock were required for two
consecutive years, and this delayed dissolution three years beyond the
time originally contemplated.[728] The Richmond Terminal trust had
provisions similar to those of the Erie.

The number of trustees also varies. The scheme proposed for the
Atchison in 1889 contemplated a trust of seven; the Baltimore & Ohio
in 1898 and the Richmond Terminal in 1894 provided for five; and the
Erie in 1896 for three; but this point is not material. When the
reorganization plan requires the consent of stockholders to an increase
in the issue of securities the consent of holders of trust certificates
is apt to be required on similar occasions during the existence of the
trust. Thus the Northern Pacific agreement of 1896 forbade the trustees
to increase the preferred stock or to issue any new mortgage, except
with the consent of the holders of a majority of the whole amount of
preferred stock trust certificates, and of the holders of a majority of
the common stock trust certificates represented at the meeting.

This ends the present treatment of the subject of railroad
reorganization. The results of the discussion may be briefly summed up
as follows:

_First._ Reorganization is most frequently an attempt to extricate an
embarrassed company from its difficulties.

_Second._ These difficulties can generally be traced either to an
unrestricted freedom of capitalization, or to destructive competition.

_Third._ The shape in which trouble appears is likely to be that of a
large floating debt or of excessive fixed charges; either or both of
which may have brought the corporation to a critical condition some
time before the actual collapse.

_Fourth._ The best practice favors the retirement of floating debt
by assessments on securityholders, though sales of securities are
sometimes resorted to, or a combination of sales and assessments is
employed.

_Fifth._ Fixed charges are composed chiefly of interest and rentals.
Interest payments are reduced by the retirement of outstanding bonds by
new bonds which bear a lower rate of interest, or by income bonds or
stock, or by a combination of securities with a fixed rate of interest
with securities upon which payment of interest is optional. Rentals may
be reduced by direct negotiation, or the leased roads may be absorbed
into the main system, and their securityholders receive new stocks and
bonds as above.

_Sixth._ The new bonds are of fewer kinds and have longer terms to run
than the bonds which they displace.

_Seventh._ This reduction in fixed charges imposes a loss on the
greater part of securityholders, both in respect to the annual interest
which they can claim, and in respect to the selling price of their
holdings. A similar loss is suffered by those securityholders who pay
the required assessments.

_Eighth._ The loss falls on securityholders according to the seniority
of their holdings,—those bonds escaping which can expect to satisfy
their claims from the selling price of the railroad at foreclosure sale.

_Ninth._ The most important development in reorganization practice
has been the increasing use of new securities bearing a fixed rate
of interest with new securities bearing a conditional rate of
interest; a use which may make the losses of junior securityholders
temporary instead of permanent, and yet safeguard the interests of
the corporation. In this connection preferred stock has gained in
popularity over income bonds.

_Tenth._ This development, and the issue of new securities for floating
debt and for other purposes, have caused the capitalization after
reorganization in all but one of the cases which we have examined to
exceed the capitalization before.

_Eleventh._ In order to perfect a reorganization additional provisions
are often inserted, which protect junior securityholders against the
reckless issue of new bonds, supply the corporation with ability
to make necessary betterments from capital account, protect the
corporation from sudden changes in control, and similarly supplement
the main clauses.

BIBLIOGRAPHICAL NOTE

Information about railroad reorganization must be gathered from a wide
variety of sources. The most important are five in number. First,
there are the annual reports of the railroads themselves. Second,
there are the files of financial and railroad papers. Third, there are
contemporaneous pamphlets. Fourth, there are memoirs and biographies
containing first-hand material. And fifth, there are government
documents, which comprise (1) regular reports by and testimony before
bodies like the state and national railway commissions; (2) reports
by and testimony taken before occasional committees; (3) legislative
records; (4) state and federal court proceedings.

Of the five sources mentioned, the files of contemporary papers are the
most useful. The _Commercial and Financial Chronicle_, the _Railroad
Gazette_, the _Railway Age_, the _Railway and Engineering Review_,
the _Railway Times_ of London, the New York _Tribune_, the New York
_Journal of Commerce_, the _Wall Street Journal_, and many others are
generally accurate and trustworthy, though it should be noted as a
limitation that they seldom have inside information, and that their
comment is not always independent. These papers are supplemented by
pamphlets and circulars. Many reorganization plans are published in
pamphlet form. Opposition to them is not infrequently thrown into the
same shape. Reports of experts are printed in pamphlets. In general,
the live literature of reorganization must be put out on short notice,
and so is issued in this informal way. The official statistics of
railroads are to be found in the reports of the railroad companies
themselves, made to stockholders or to supervisory government bodies.
These statistics, like the news items in the financial and railroad
papers, must be used with care. They are sometimes incomplete, and
they are sometimes purposely misleading. Nevertheless, they are
useful, and serious inaccuracies in any of them are usually exposed
within a few years after their original publication. The material
to be found in legislative records is not abundant. Railroads
almost invariably, however, appear before the courts in the course
of their reorganizations, and in the decisions of these tribunals
some facts of interest may be found. The records of the receivership
of the Union Pacific have been published in fourteen volumes. The
decision of the United States Supreme Court in Pearsall _vs._ Great
Northern[729] blocked the first of the reorganization plans proposed
for the Northern Pacific in 1895. An earlier decision[730] enabled
the Union Pacific to postpone the payment of interest upon the public
debt until the principal should have fallen due. The Erie has been
at times almost continuously before the courts, and the same is true
of the Reading during its reorganizations, of the Northern Pacific,
and of other roads. The student is most fortunate when he can uncover
testimony before government committees, of men who have taken part
in reorganization proceedings, or who are personally acquainted with
developments which have led up to railroad failures. Mr. Blanchard,
before the Hepburn Committee,[731] and Mr. Fink, before the Hepburn
and the Cullom Committees,[732] helped their hearers to understand the
policy which finally resulted in the failure of the Baltimore & Ohio.
The report of the Poland Committee disclosed the scandal of the Crédit
Mobilier.[733] The testimony of Gould, Adams, Ames, Holmes, and others
before the United States Pacific Railroad Commission of 1887–88[734]
made clear the iniquity of the Union Pacific reorganization of 1880.
The statements of Mr. Pierce before the Senate Committee on Pacific
Railroads in 1896[735] explained the attitude of the Union Pacific
towards the repayment of that company’s debt to the Government. The
testimony of Messrs. McLeod, Rice, Harris, and others before the
Industrial Commission of 1900 threw much light upon the Reading
bankruptcy of 1893. The arguments of counsel in the matter of export
differentials, reprinted in the fifth volume of the Elkins Committee
report,[736] gave valuable information on the subject of trunk-line
competition. Many of the witnesses before these committees are frank
in criticism of the railroads with which they have been connected.
Others are forced to admissions by the keen questioning to which they
are exposed. The only similar material to be found elsewhere lies in
memoirs, such as those of Henry Villard,[737] or in biographies like
Oberholtzer’s Life of Jay Cooke[738] and Pearson’s An American Railroad
Builder[739] which make use of private papers of men prominent in
railroad finance. Perhaps White’s Book of Daniel Drew,[740] Depew’s
Retrospect of Twenty-Five Years,[741] and the Life of Isaac Ingalls
Stevens by his son,[742] should be included in this class.

This enumeration, while in no way exhaustive, indicates the principal
sources from which material may be obtained. Secondary works do not
exist which treat solely of railroad reorganization. There is an
article by E. S. Meade in the _Annals_ of the American Academy,[743]
articles by Simon Sterne in the _Forum_,[744] and an article by
A. Lansburgh in _Die Bank_,[745] but no books of which the author
is aware. Mention may be made of an intelligent discussion of an
industrial reorganization by A. S. Dewing in the _Quarterly Journal of
Economics_.[746] _Poor’s Manual_ for 1900 contains the most convenient
set of general statistics. On railroad receiverships, besides legal
works, there is a monograph by H. H. Swain,[747] which has a brief
bibliography, and articles in the _Forum_, _North American Review_, and
other periodicals.

On the history of the great American railroad systems the literature
is also quite inadequate. The Union Pacific has been written up
frequently, because of its relations with the United States
Government. Works by Davis,[748] von der Leyen,[749] Bromley,[750]
Dillon,[751] Crawford,[752] Hazard,[753] and White[754] treat various
phases of the company’s development up to its final reorganization, an
article by Meyer[755] describes the settlements between the Pacific
railroads and the Government, and another article by Mitchell in the
_Quarterly Journal of Economics_[756] deals with Union Pacific finance
since that time. There may also be mentioned an account by Bailey,[757]
which covers the whole of the road’s history, but in a superficial
way, and a vicious attack by Robinson upon all the government-aided
lines.[758] The student of the Erie has at his disposal the elaborate
narrative by E. H. Mott,[759] the chapters by Charles Francis Adams,
Jr.,[760] and the sketch by Crouch.[761] Milton Reizenstein has
dealt with the progress of the Baltimore and Ohio up to 1853,[762]
and for this road there is material to be found in Smith’s Book of
the Great Railway Celebrations of 1857,[763] and in a compilation
of the Laws, Ordinances, and Documents Relating to the Baltimore and
Ohio Railroad, published in 1840.[764] For the Northern Pacific the
history by Smalley covers in popular style the period from 1864 to
1883,[765] the careful History of the Northern Securities Case, by
B. H. Meyer, treats of an interesting later development,[766] chapters
in von der Leyen’s book contain acute and independent discussions
of Northern Pacific as well as of Union Pacific finance,[767] and
there is a fifteen-page pamphlet by Chapman entitled The Northern
Pacific Railroad.[768] Schlagintweit in 1884 described his travels
on the Santa Fe and Southern Pacific.[769] Wilson has written two
volumes upon the Pennsylvania Railroad,[770] while Worthington[771]
and Bishop[772] have described the internal improvements undertaken
by the state of Pennsylvania. Ackerman is the author of a Historical
Sketch of the Illinois Central Railroad,[773] and Hollander[774]
and Ferguson[775] of works on the Cincinnati Southern. Potts[776]
and Briscoe[777] have written on railroads in Texas. The Chicago &
Northwestern has published a volume called Yesterday and To-day,[778]
which contains some information. Hinsdale has worked up the History
of the Long Island Railroad.[779] Bishop has sketched the history
of the St. Paul & Sioux City Railroad.[780] Bliss is the author
of a Historical Memoir of the Western Railroad.[781] Cary in 1893
described the Organization and History of the Chicago, Milwaukee
& St. Paul Railroad Company.[782] Phillips discusses in excellent
fashion the early history of a number of Southern carriers.[783] The
autobiography of George Francis Train[784] and Smyth’s biography of
Henry Bradley Plant[785] are serviceable. Works like those of Van
Oss,[786] Snyder,[787] Carter,[788] and Spearman,[789] and brief
descriptions which have appeared in the columns of the _Railway
World_ and in _Moody’s Magazine_, treat of a number of railroads, but
make no attempt at a scholarly examination of any one. Some general
works like Ringwalt’s Development of Transportation Systems,[790]
Adams’ Railroads: Their Origin and Problems,[791] Hadley’s Railroad
Transportation,[792] Kupka’s Die Verkehrsmittel in den Vereinigten
Staaten von Nordamerika,[793] Singer’s Die Amerikanischen Bahnen,[794]
Myers’ History of the Great American Fortunes,[795] Bancroft’s History
of the Pacific States,[796] and Chronicles of the Builders,[797]
Davidson and Stuvé’s Complete History of Illinois,[798] Hollander’s
Financial History of Baltimore,[799] Sanborn’s Congressional Grants
of Land in Aid of Railways,[800] Haney’s Congressional History of
Railways,[801] and Million’s State Aid to Railways in Missouri,[802]
contain incidental information about individual railroads.

These books are of service. Their number is, however, small and their
scope limited. It is surprising that a field so rich as that of the
history of American railroad systems should have attracted so little
attention from competent students. It is not too much to say that the
history of the Erie by Mott is the only comprehensive work of the kind
which our literature possesses, and that is already thirteen years
old.