bonds of Texas roads reached maturity. The physical valuations applied by the Commission as a standard of measurement were generally well below the volume of bonds outstanding, to say nothing of the capital stocks; and revaluation was denied on the ground that accounts could readily be kept up to date by adding the yearly reinvestments of income to the original figure. If prohibited from refunding the maturing bonds, dollar for dollar, the roads would be unable to issue enough new ones to take up the old. Enabling legislation to mitigate the rigor of the law was urgently sought but in vain. The only escape for the roads was to issue new bonds to the full amount of their physical valuation and then to leave the balance as a floating debt. To the outsider, it appears as if this policy of excision were unduly severe. If, as in the Delaware and Hudson case, there was evident over-capitalization to be corrected, it seems as if the wiser plan would be to permit refunding, but to insist upon guarantees that the company would make amends within a reasonable time by a gradual process of amortization.1

(5) Consolidation of railroad properties offers an exceptionally favorable opportunity to increase capitalization surreptitiously. The English practice of splitting" securities had its beginnings in connection with merger operations. New classes of stocks known as preferred and deferred shares were put forth, each of them equal in volume to the total original stock outstanding.2 A prime advantage of consolidation, of

1 Certifications of refunding operations by other state commissions are given in the Economic Review, vol. xix, Sept., 1914. Even later ones approved by public authority will be found in the following cases: permitting the St. Paul to exchange $470,000,000 of its own bonds for those of the St. Paul extension, P. S. C., Missouri, vol. i, 1913, p. 305; and prescribing the terms of exchange, discount, etc., of $28,000,000 of Iron Mountain bonds, ibid., p. 105.

McDermott, Railways, p. 164.

course, is that the constituent companies may be so gerrymandered that successful ones with surplus earnings may average their rate of return downward by combination with other properties less favorably situated. A weak corporation, whose stock is quoted say at $50, may be merged in a second corporation whose stock is worth $150 per share. The latter may then issue new stock of its own in exchange for the $50 stock, share for share. Such an operation as this may not only deceive the public, by establishing a fictitious capitalization far in excess of the worth of the investment, but it may also constitute a fraud upon the shareholders of the more prosperous company by diluting the value of their holdings. In ordinary offerings of new shares at favored prices, the stockholder finds compensation for the fall in the value of his shares in the bonus or

right" which he receives. But in these cases of consolidation, the bonuses or rights may go to the favored holders of shares in the weaker company alone. It is conceivable of course, that advantage may flow to both concerns from the merger, particularly through the extension of the credit of the stronger to enable the weaker one to make the expenditures necessary to bring about reduced operating costs. This has been done of late by parent roads outside Texas to subsidiaries therein, subject to the drastic limitations of the Stock and Bond law.1

In Texas the details of all railroad mergers of this sort are most rigidly scrutinized, in order to prevent such an increased capitalization. Mere consolidation of roads in the Missouri, Kansas & Texas system in 1891, for example, increased the aggregate of stock and bonds

1 The analogy with electric lighting properties is imperfect, inasmuch as the latter may concentrate all operation in the stronger plant, while in the case of railways both must still operate in their respective territories. Economic Review, xix, Sept., 1914.

by $12,475,000, or $19,207 per mile of road. This, it will be noted, was before the enactment of the Stock and Bond law.1 Whether the public interest is prejudicially affected in such cases or not would seem to be dependent largely upon whether the companies absorbed were worth the price paid for them; or, in other words, whether efficiency and earning power were promoted in a degree suitably proportioned to the enhanced capitalization. And, even so, the expediency in the public interest of requiring amortization of the increase in capitalization, as required by the best modern practice, is obvious.2

All previous demonstrations of the evil of dilution of capitalization as a concomitant of consolidation are eclipsed by the recent prostration of the once substantial New York, New Haven and Hartford Railroad. Within nine years to 1912, the outstanding securities of this company increased from $93,000,000 to $417,000,000, altho the operated railroad mileage increased only fifty miles.1 Issues of new stocks and bonds during this period brought in about $340,000,000. Of this sum,

$40,000,000 was spent for the purchase of lines previously operated under lease or otherwise indirectly. For betterments and equipment, $96,000,000 was expended. This left a sum of about $204,000,000 which in nine years was invested in properties outside its own

1 Report of the Railroad Commission to the Governor on the subject of mergers, Nov. 5, 1904; reprinted in full in the Dallas News of Nov. 27, 1905.

Cf. New York Public Service Commission practice, reviewed by the author in Economic Review, Sept., 1914.

Best outlined in 27 I. C. C. Rep. 581. Cf. also Report to the Joint Board on the the Validation of Assets and Liabilities of the New York, New Haven and Hartford Railroad under Chapter 652, Acts of 1910, by George F. Swain, Engineer in Charge; published in Report.of the Massachusetts Joint Commission on the New York, New Haven & Hartford Railroad Company, February 15, 1911, pp. 51-154. [Known as the Validation Report.] Other details concerning steamship lines are given in the above I. C. C. report, supplemented by the further testimony taken in May, 1914; also Report U. S. Bureau of Corporations on Transportation by Water, pt. 4, 1913, p. 17. The second extended I. C. C. Rep. has just been issued (July, 1914); I. C. C. Rep. 31.

railroad sphere,

that is to say in trolley companies, steamship lines and even electric light and power plants. A tale of more reckless disregard of the interests of the public and of investors alike, a more complete breakdown of service in the form of intolerable losses and delays and appalling accidents,—has never been spread upon the records. It is an involved affair in entirety. We must be content to outline it by territorial samples.

The Connecticut trolleys in the New Haven system were originally leased as the Connecticut Railway and Lighting Company. This aggregation of roads had been formed by the consolidation of nine smaller concerns in 1900. Bonds to the amount of $9,350,000 and shares amounting to $15,000,000, — a total of $24,350,000,- were exchanged for a former combined capitalization of $8,210,000, at the time of consolidation.1 This flagrant over-capitalization was characteristic of the general situation in that state. The absence of rigid governmental oversight, outside of Massachusetts, created a striking contrast in this regard, to which attention will be called in another connection. Where the New Haven Railroad agreed by purchase and lease to support this inflated capitalization, the operation practically, of course, amounted to dilution of the value of its own securities to a corresponding degree. The Massachusetts Validation Commission in 1911 found that, even making no allowance whatever for depreciation, $13,000,000 of a total par investment of $40,000,000 of the New Haven railroad in these Connecticut trolleys represented no tangible value whatever. Still less, apparently, did it represent earning power.

The roundabout processes by which the New Haven obtained control of its trolley lines in Rhode Island may

1 Report of Commission de Public Service Corporations, Connecticut, 1909, pp. 811; New York Evening Post, Nov. 23, 1912.

best be described by direct quotation from the report of the Interstate Commerce Commission.1

"In 1902 the United Gas Improvement Company, generally understood to be an institution backed by Philadelphia capital, entered the trolley field in Rhode Island. A corporation known as the Rhode Island Company was organized which issued its capital stock in the sum of $2,000,000 to the Improvement Company, receiving in return $2,000,000 in cash. The Rhode Island Company thereupon leased three trolley lines, which embraced in the main all the lines in Providence, Pawtucket, and the immediate vicinity.

"The Improvement Company now proceeded to organize what was known as the Rhode Island Securities Company for the purpose of holding the stock of the Rhode Island Company. The Improvement Company turned over to the Securities Company the $2,000,000 of stock in the Rhode Island Company and received therefor without any further consideration $12,000,000 of the capital stock of the Securities Company and $3,500,000 of its 4 per cent bonds. This resulted in the issue to the Improvement Company of $15,500,000 of securities for $2,000,000 in money.

"This was in 1902. In 1904 the New Haven began its campaign for the acquisition of the trolley lines of southern New England, and soon after purchased a block of the stock of the Rhode Island Company. In 1906 it perfected arrangements for the acquisition of the entire stock of that company. Instead, however, of purchasing that stock directly, it arranged to do it indirectly by taking over the Securities Company. What the New Haven did was to organize a third corporation, the Providence Securities Company, which exchanged its 4 per cent debentures guaranteed by the New Haven Company for the stock, bonds, and notes of the Rhode Island Securities Company substantially at par. There was a cash payment of $10 per share by the stockholders of the Rhode Island Securities Company and an adjustment of $3 per share against this on account of interest; there were certain bookkeeping entries one way and the other, but the upshot of the whole transaction was that the New Haven Company issued its obligations to the Improvement Company and others and received in exchange at substantially dollar for dollar these inflated securities of the Rhode Island Company.

"Representatives of the New Haven Company earnestly insisted that this company had not watered the stock of the Rhode Island Company, and this, strictly speaking, is true. The improvement Company turned in the water and the New Haven Company converted that water into wine. In whatever aspect the transaction is viewed the New Haven gave $13,500,000 for nothing."

1 27 I. C. C. Rep. 581.