QJE, 28 (1913-1

THE DEVELOPMENT BY COMMISSIONS OF THE PRINCIPLES OF PUBLIC UTILITY

VALUATION

SUMMARY

Theories of valuation in process of development by Commissions, 269.- Plant and equipment. Reproductive" value or original cost? 271. - Treatment of land value; peculiar position of St. Louis and New York Commissions, 274. Pavements, 279. - Overhead charges; two methods of computing, 281. — Development expense and going values; Wisconsin method and New York method, 284. - Peculiar method in New Jersey, 287.- Conclusion, 291.

THE Supreme Court of the United States has established the principle that a public utility is entitled to a reasonable return upon the fair value of the property being used in the public service, and that the question of such reasonableness is a matter for judicial review. It has failed, however, to formulate any definite principle as to what constitutes the fair value of a property for rate making, other than to point out that certain factors must be given consideration,' and to say that the value which should be used as a basis for rates is the value of the property at the time it is being used.2

In spite of the indefiniteness in the decisions of the Supreme Court, there are being developed in the United States at the present time well defined precedents and usages in the valuation of public utilities for rate making purposes. Theories of valuation are being developed by the public service commissions, to whom the legislative bodies have delegated the regulatory power.

1 Smythe v. Ames, 169 U. S. 466.

San Diego Land and Town Co. v. National City, 174 U. S. 739.

It is to the decisions of the commissions which regulate rates that one must look for the development of theories of valuation, in their intricate details and refinements. The purpose of this paper is to describe and compare some of the principles of valuation for rate making purposes developed by some of the leading public utility commissions in the United States.1

It is noteworthy that the Massachusetts Board of Gas and Electric Light Commissioners, the oldest rate making commission in the United States,2 has contributed nothing to the theory of valuation. No specific appropriation has ever been given to the Board for the purpose of making valuations, and no organization has ever been created. Since its organization, the Board, under legislative direction, has imposed restrictions upon the issue of securities. It has been customary to base an estimate as to the amount upon which the company should be permitted a reasonable return, upon the amount of securities which have been approved by the Board or which might have been so approved. Therefore this commission has seldom made valuations, and when it has based a rate to the consumer upon the value of the property, it has failed to indicate the principle by which it arrived at a valuation. But other state and municipal public utility commissions, all of which have been established since 1907, have developed a considerable body of theories and principles of valuation.

1 The commissions of the various states which possess some powers of regulation of railroads only are not referred to in this paper. Only "public utility commissions " are included, that is, those possessing power over several utilities. The California and Wisconsin Railroad Commissions, herein referred to, have wide powers of regulation of various utilities.

2 The Massachusetts Railroad Commission was established in 1869, but it cannot fix rates, its powers being only recommendatory. The Board of Gas Commissioners was organized in 1885, and in 1887 was re-organized into the Board of Gas and Electric Light Commissioners.

PLANT AND EQUIPMENT

The general rule is to appraise plant and equipment at its present, or " reproductive," value. This amount is arrived at in various ways, sometimes by a valuation conducted by engineers in the regular employ of the commission, sometimes by the testimony of expert witnesses familiar with the particular business and plant values therein, sometimes by a valuation conducted both by engineers for the company and for the commission. In the two cases last named, the amount often represents a compromise. Whatever the method, the amount accepted is presumed to represent proximately the depreciated value of the plant and equipment owned by the company, at the existing prices of land, labor and materials.

The St. Louis Public Service Commission, however, which has proven itself probably the most efficient and successful municipal commission, employs the original cost theory, and is its leading advocate. In its valuation of the property of the Union Electric Light and Power Company in 1911, the Commission rejected the theory of cost of reproduction, saying that "it disregards the actual conditions under which the property was produced, and sets up a purely hypothetical case." Therefore, instead, the Commission assigned to each item" its original cost in place and ready for service." Again, in its report on the valuation of the United Railways Company, in November, 1912, the St. Louis Commission says "The Commission in its valuation has relied mainly upon original cost as the theory most calculated to bring about a just result. . . The Commission believes that in trying to determine the amount of property upon which a public service company is entitled to a reasonable return from the public

... the circumstances under which that property was created and placed in the public service should be taken into account. This view leads us to the use of the original cost theory where practical. . . ." The method by which the original cost is computed by the Commission is to make a complete detailed inventory of the entire physical property, and then assign to each item its original cost, based upon costs as taken from the contracts in the files of the company, where possible, and when no such contracts are in existence, on estimates collected by the Commission's engineers.

While the New Hampshire Public Service Commission has not yet developed a theory of valuation, it is evident that it regards original cost as an extremely important factor. For in a recent rate case, it held that it was unnecessary to make a valuation of the property, since it was clear that the original cost of the property, less depreciation, was in excess of the amount upon which the company was earning a return.

In rejecting the original cost theory, the Connecticut Public Utility Commission says: "We do not think that the original cost of construction, whatever that may have been, the price paid for the line by the company, are proper standards to determine the value of the plant and equipment for which the company is entitled to receive a fair income, but that the cost of reproduction at the present time in this particular case is a more accurate standard.” 3 This reasoning seems to be accepted by the commissions of the following states, all of which base their valuations upon present or reproductive value: California, New Jersey, New

1 Report on the United Railways Company of St. Louis, by the St. Louis Public Service Commission, 1912, p. 12.

2 In Brown et al. v. Exeter, Hampshire and Ames Street Railway, Report of New Hampshire Public Service Commission, 1912, p. 139.

• First Report, Connecticut Public Utilities Commission, 1912, p. xxxvi.

York, Maryland, and Wisconsin, and also by the Board of Public Utilities of Los Angeles.

Which of these principles is the more nearly just? In the opinion of the author, either is fair, if accompanied by an appropriate return. The rate of return, however, should depend upon which of these methods is adopted. If present value is to be taken, the result is that the company will be called upon to bear the burden of any decrease in the value of its property, and to accept a lessened return because of such depreciation. It is true that the company will also be entitled to the benefit of any appreciation. Yet the amount upon which it may earn a return in the future is indefinite and uncertain. The rate of return should therefore be sufficient to compensate the corporation for assuming this risk. In some cases it may be that the possibility of increased value, due to the ownership of land, will more than offset the possibility of a lessened value of the other property. But land does not ordinarily represent a large portion of the value of municipal utilities, operating in the public highways. Whenever a company is called upon to assume a risk as to the future value which will be placed upon its property, that risk should be given proper consideration in establishing the rate of return to be permitted. If, however, original value is to be applied, then the company will be freed from any risk as to future fluctuations in the value of its property, since the amount upon which it may expect a return is established once and for all. In such case, the rate of return permitted should properly be somewhat less. Theoretically, either method of valuation is fair, if the rate of return is regulated accordingly. Practically, however, the theory of present value is much easier to apply, since but few corporations have records by which to prove the original cost. The repro