definition of railroad reorganization—causes of the financial difficulties of railroads—unrestricted capitalization and unrestricted competition—problem of cash requirements—problem of fixed charges—distribution of losses—capitalization before and after—value of securities before and after—provision for future capital requirements—voting trusts—summary.

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 more335 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 of336 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.337 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 3? 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

338 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 works339 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 yielded340 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 was341 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 matters342 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

operating

expenses 1893

fixed

charges surplus operating

expenses 1892

fixed

charges surplus ?

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. & danv. and e. tenn. 73.49 25.63 ?.12 68.79 31.15 ?

u. pac. 59.66 43.18 51.91 36.42 11.66 ?

atchison 77.47 24.96 77.16 21.59 ?1.24690 ?

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 averaged343 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

operating

expenses 1893

fixed

charges surplus operating

expenses 1892

fixed

charges surplus ?

c., b. & q. 64.46 23.12 12.41 65.17 20.86 13.96 ?

c., m. & st. p. 65.95 20.78 13.26 64.00 22.36 13.63 ?

c., r. i. & p. 71.72 13.31 14.96 69.88 19.83 10.28 ?

great no. 50.44 34.54 15.01 52.66 32.98 14.34 ?

ill. cen. 61.92 25.84 12.23 64.58 23.99 11.12 ?

n. y., n. h. & h. 72.31 16.07 16.36 73.36 ?8.77 17.86 ?

n. y. c. 68.79 20.84 10.36 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 consolidated344 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 4?s 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,345 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 have346 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 in347 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 share694 for their work of co?peration 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.348 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 of349 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, or350 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 solely351 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 before352 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

stock 1st

preferred 2d

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 nothing353 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 ?

assessments price

1 month

after plan price

6 months

after

reorganization assessments price

1 month

after plan price

6 months

after

reorganization ?

atchison $10 $?5? $13? ?

b. & o. ?20 ?12? ?56? $20 $114? ?

erie ?12 ??8? ?14? ??8 $22 ??36? ?

n. pac. ?15 ??1? ?13? ?10 ?10 ??26? ?

reading ?20 ??2? ?22? ?

richm. term. ?10 ??2? ?11? ?

e. tenn. ???? 7.20 ???? ??6? ??3 ?10 ??13? ?

u. pac. ?15 ?10? 20 ?

four reorganizations before 1893 ?

e. tenn., ’86 ??6 ??2? ??5? ?

erie, ’59 ??? 2? ???2? ?

erie, ’77 ??4 ?18? ??2 ??29? ?

reading, ’86 ?10 ?38? 58 ?10 53?700 ?

354 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 $17? 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 increase355 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 the356 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

357 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 ?

road before after per cent

decrease per cent

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 ??9,043,944709 20.81 ?

richm. term. system ??7,498,584 ??4,195,925 44.04 ?

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 $10,485,882 119.3710? ?

358 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 ?59.0712 ?

359 a summary of the preceding tables is as follows:

fixed charges before and after reorganization

seven reorganizations, 1893–8 ?

per cent decrease per cent increase ?

absolute

charges charges to

income charges

per mile absolute

charges charges to

income charges

per mile ?

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 17.6713 ?

360 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 the361 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 junior362 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 the363 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 cent number amount per cent number amount per 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 ?

? 4? ?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 ?

? 3? ?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 ?

? 4? ??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:

period prior to 1893

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 per364 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 outstanding365 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 the366 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.

367 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 in368 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 they369 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 118? 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 into370 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:

fixed charges

six reorganizations, 1893–8 ?

interest rentals, etc. total charges ?

decrease increase decrease increase decrease increase ?

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 29.0 119.3717 ?

it appears that while the decrease in rentals was of little importance371 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 of372 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 these373 companies bear before and after reorganization to the total capitalization before.

capitalization

seven reorganizations, 1893–8 ?

before after ?

bonds preferred

stock common

stock total? bonds preferred

stock common

stock total ?

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 27.3719 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 old374 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 issued375 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

of month one

year before failure lowest quotation

of month one

year after

reorganization lowest quotation

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 reorganizations376 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 junior377 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 year

before failure value

one year

after

reorganization per cent

increase

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 described378 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

prices for 26 railroad common stocks

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 73? for the earlier month, and 71? 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 in379 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 4? 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 cent723 ?

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 to380 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 the381 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 equipment382 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 assured383 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.

384 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 of385 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 provisions386 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.