Recent Tendencies in Valuations for Rate-Making Purposes

• Published date: 01 May 1914
• DOI: 10.1177/000271621405300121
• Date: 01 May 1914
• Subject Matter: Articles

RECENT TENDENCIES IN VALUATIONS FOR RATE-
MAKING PURPOSES
BY EDWIN GRUHL,
Assistant to President, The North American Company.
The investor in public utility securities has frequently expressed
regret that there has been no definite, authoritative statement of the
principles of the &dquo;rate-making&dquo; value. The facilities for the regula-
tion of rates have, within the past few years, been materially increased.
Commissions, with broad powers of regulation, are now provided in
most states. The procedure with which investigations may be started
is relatively simple. A rate case is no longer the indication of wide-
spread dissatisfaction in the community, but more often the result
of individual complaint. Nor have the possible consequences in any
way been lessened. The inquiry in rate cases is usually directed
toward the income and thus the &dquo;investment&dquo; value of the entire
public utility. Under prevailing practices the testimony does not
concern itself principally with the reasonableness of the rate, but with
the size of the resulting return upon the investment. This situation
has developed the need for some unqualified declaration of principles
by which the prospective investor may assure himself in a preliminary
manner of the clear title of the investment to which he is about to
contribute. With a number of utilities, inquiries as to the reasonable-
ness of prevailing rates have already run their course and the relation
of the investment to the customer has been more or less definitely de-
termined. In the vast majority of cases, however, these assurances
are still lacking. The examination of decisions as to the elements
of value for rate-making purposes are, therefore, no longer of theo-
retical or academic interest, but have assumed large practical im-
portance.
The indefiniteness in decisions as to the principles of &dquo;rate-mak-
ing&dquo; value are probably due to two reasons: The equities of investor
and customer are a complex relationship which cannot readily ~ be
encompassed and defined as a single arithmetical process to be applied
to any set of facts. The court of last resort, moreover, in reviewing
the determination of value by local authorities and commissions, has
219

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220
not been concerned so much with the examination of economic doc-
trines or the wisdom of legislative policies of regulation as with the
application of a particular rate to the property rights involved. It
is, therefore, not surprising that the language in the leading case,
Smyth vs. Ames, 169, U.S. 466, decided in 1898-
We hold, however, that the basis of all calculations as to the reasonable-
ness of rates to be charged by a corporation maintaining a highway under legis-
lative sanction must be the fair value of the property being used by it for the
convenience of the public. And in order to ascertain that value, the original
cost of construction, the amount expended in permanent improvements, the
amount and market value of its bonds and stock, the present as compared with
the original cost of construction, the probable earning capacity of the property
under particular rates prescribed by statute, and the sum required to meet
operating expenses, are all matters for consideration, and are to be given such
weight as may be just and right in each case. We do not say that there may not
be other matters to be regarded in estimating the value of the property-
should be reiterated rather than more definitely stated in the Minne-
sota rate cases, 230 U.S. 352, 434, decided June 9, 1913-
The ascertainment of that value is not controlled by artificial rules. It is
not a matter of formulas, but there must be a reasonable judgment having its
basis in a proper consideration of all relevant facts.
It would be reasonable to suppose, however, that the state com-
missions dealing with the detailed evidence as to values would pro-
ceed in an identical manner and adopt common practices and theories.
But this is far from being the case, although there are certain ten-
dencies which point toward uniformity. The earlier rate decisions
have already been summarized in various texts and it would be repe-
tition to refer to them in detail in a short discussion. Attention
is therefore directed, in this article, to the more recent cases covering
the latter part of the year 1912 and the year 1913, which particularly
reveal departures from previous rulings. Comparisons of this kind
are seldom conclusive.
It is probably true that a study of the actual
facts and conditions surrounding each particular case with which the
commission was undoubtedly familiar, but to which there are only
meager clews in the reading of the decision, would probably disclose
that what rate regulation is endeavoring to accomplish is full and
abstract justice, and that much of the theoretical background for
these decisions has been filled in and elaborated in extended dicta,

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221
after and not before the actual decision has been reached. In no
other way is one able to explain the great diversity of viewpoint with
which one is confronted in any comparative analysis of the so-called
principles of value for rate-making purposes.
It is reasonable to assume also that if any single economic law
underlies the proper rate-making value it will not be established until
every available viewpoint and application have been exhausted. Eco-
nomic principles of money, of international trade and of taxation
have taken a long time to matu;re and have been preceded by innu-
merable theories and propagandas before they have finally reached the
stage where generalization has been proper. Such sweeping and con-
flicting conclusions as those of Professor JohnH. Gray, former director
of investigation of the National Civic Federation, before the Ameri-
can Economic Association, that
on any sound principle there should be no valuation for rate regulation but
history, that is, a statement of outlay, of money spent and services ren-
dered, nothing more..... As an agent, the utility exercises the right of
eminent domain, must give an account of its stewardship, is subject to contin-
uous control, is liable for compulsory service, and must cooperate with all other
public agents of its principal, the state,
or those of a committee of the American Society of Civil Engineers
upon the subject of valuation for purposes of rate making that
the committee believes
....
a valuation of an old property based on
its actual cost to be generally impracticable, making it necessary to adopt the
cost of reproduction method....
In the opinion of the committee it would be entirely just and equitable
to
...
provide by law that future public service properties should be
valued on the basis of their actual reasonable existing investment, and to
determine or limit rates upon such a valuation if the service rendered permits,
seem both, in the light of present decisions and practices, premature.
In the recent rate cases the cost of reproduction new has con-
tinued to be the factor of value given the greater attention. It is
accepted as an important element in the Minnesota cases, 230 U.S.
352,452:
The cost-of-reproduction method is of service in ascertaining the present
value of the plant, when it is reasonably applied and when the cost of reproduc-
ing the property may be ascertained with a proper degree of certainty. But it
does not justify the acceptance of results which depend upon mere conjecture.

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222
But estimates of the increased value of right-of-way real estate are
limited to the normal market value of land in the vicinity, and the
court cautions against the use of hypothetical additions over and
above such normal values:
Assuming that the company is entitled to a reasonable share in the general
prosperity of the communities which it serves, and thus to attribute to its prop-
erty an increase in value, still the increase so allowed, apart from any improve-
ments it may make, cannot properly extend beyond the fair average of the
normal market value of land in the vicinity having a similar character. Other-
wise we enter the realm of mere conjecture. We, therefore, hold that it was
error to base the estimates of value of the right-of-way, yards and terminals
upon the so-called &dquo;railway value&dquo; of the property. The company would cer-
tainly have no ground of complaint if it were allowed a value for these lands
equal to the fair average market value of similar land in the vicinity, without
additions by the use of multipliers, or otherwise, to cover hypothetical outlays.
A better recognition of the limitations of appraisal by engineers
and the necessity of providing against omissions in estimating costs
other than those of mere labor and material have led to an increase
in the percentage allowance for so-called overhead items of the con-
struction, including superintendence, legal expenses, interest during
construction, engineering and contingencies. It is noted that the
Wisconsin commission, which, in its earlier cases, allowed 12 per cent
for such items, has finally made an increase of its allowance to 15 per
cent. In its decision City of Milwaukee vs. Milwaukee Gas Light
Company, decided August 14, 1913, 12 W.R.C.R. 441, 444, the com-
mission held:
The proper allowance for this item cannot be stated in general since it
depends upon many variable conditions, particularly upon the make-up of the
unit prices to the sum of which it is to be applied. All of this overhead might
be added to the individual items, but since a great deal of it is not easily as-
signed to any particular...