Senator BAUCUs. Dr. Sattler, if I may ask, how long have you been studying this question, or how did you get into holding company analysis? What led to this?

Dr. SATTLER. I have been studying this phenomenon for about 8 years. I originally became interested in it because my specialty in economics, in addition to transportation economics, is a field called industrial organization, which roughly translates into the study of industry structures and how those structures affect economic performance. I noted the rapid movement of railroads into holding companies and wondered if that would have any impact on the railroad itself.

I should state that if there was not a substantial public interest in maintaining rail service, if the railroad were just XYZ Corp., and a holding company was formed, and if the XYZ Corp. was eventually dropped because it did not earn sufficient return, there would really be no problem with that. That is the private market at work. It is the public interest aspect of the railroad that really causes the problem; the fact that the Government is charged with maintaining an effective transportation system. So I was, in my research, motivated to find out if this change in the structure of the company would have any impact on the railroad itself.

Senator BAUCUS. As I understand, your general conclusion is that the larger the profit gap between the railroad and its diversified properties-that is, the lower the return in the profits of the railroad, compared with the other properties, the greater the chances are that further diversification will occur at the expense of the railroad? Is that basically it?

Dr. SATTLER. That is correct. The more unprofitable the railroad going into the holding company, the more likely that profit gap will be greater. Research has indicated to me that the larger that profit gap, the more rapid the diversification; the more rapid the diversification, the more deterioration occurs in the railroad performance.

Senator BAUCUS. As I understand it, you say the Burlington Northern Railroad operations are in the middle, that is, among those that you have studied?

Dr. SATTLER. That is correct. Particularly among the western roads, they are certainly not one of the more efficient nor one of the more profitable western roads. But all the western roads are generally more profitable than most U.S. railroads. So viewed with respect to comparable railroads, namely, the roads in their region, the western roads, they are average to below average.

Senator BAUCUS. Would you say you are for or against regulation of the transportation industries? Where are you in all this?

Dr. SATTLER. Well, I am in somewhat of a difficult position, because I am really for the deregulation of the transportation industries. I was very much for the deregulation of the airline industry; I am for the deregulation of trucking, and I am for the deregulation of the railroads, as well. I believe in giving the railroad companies' management sufficient room to make business decisions that either fail or succeed on their own and not be hindered by regulations. So in that sense, I am very much against regulati Senator BAUCUS. But you seem to want more r

Dr. SATTLER. That's right, and implicitly, that is a form of regulation. But I think it is important here to go back to the formation of the holding companies, which I would argue, was to escape the regulation. Now, we still have regulation. If the partial deregulation in the railroads results in more efficient railroad performance and higher rates of return, then given my theory and model, we really have very little to fear, because the railroads will be doing very well, competing with alternative investments. The monitoring will then become a redundant activity. But at this point, with the relatively low rates of return of the railroad, I think that we ought to monitor this holding company activity because it has been a clever attempt by railroad firms to escape Interstate Commerce Commission regulation. And I might add, I am not at all unsympathetic to their attempt. I think any business, by its very nature, wants to escape regulation that results in low profits. The monitoring is justified on the public interest argument mentioned earlier.

Senator BAUCUS. Do you have any examples, or do you know of any instances, where there was a railroad that was relatively healthy before a holding company was formed, but then deteriorated?

Dr. SATTLER. Yes. I can cite one example, the Illinois Central Gulf Railroad. In 1962, the Illinois Central Gulf Railroad formed a holding company, Illinois Central Industries. The chief executive of the holding company, Mr. Johnson, steadfastly maintained that his interest was to maintain the railroad at all costs, and in fact, the holding company would work to the advantage of the railroad, raise more capital, would plow that capital back into the railroad, and he argued that the holding company was the most wonderful thing ever to happen to the railroad industry.

By 1967 or 1968, Illinois Central Industries had started to diversify rather heavily, and they started to acquire a number of other business firms. By the early seventies, their diversification had increased to such an extent that the railroad had less than half of the total operating revenues of the holding company, and all of a sudden, the maintenance policy with respect to the railroad changed. Less money went into the railroad. The financial health of the railroad deteriorated, and Illinois Central Industries now finds itself in the position of owning Dad's Root beer, Pepsi-Cola Bottlers, Midas Muffler-a number of firms having little to do with the railroad, but trying to sell the railroad right now. In fact, they have been trying to sell the Illinois Central Gulf for several years. Senator BAUCUS. But is it fair to say that this is an exception, though, to your final analysis?

Dr. SATTLER. It is an exception to my general analysis.

Senator BAUCUs. And if that is true that it is an exception, what happened here? What explains the exception?

Dr. SATTLER. Well, apparently, as the company diversified other investments were more attractive. You have to remember that even though the Illinois Central Gulf Railroad was relatively profitable as railroads go, it was still well below the overall average rate of return for overall industry. Therefore, alternative investments became more and more attractive to the holding company, and as a result, they needed money. They used the money from the railroad to buy all of these other firms and the railroad suffered.

Senator BAUCUS. And how does that situation compare with the BN?

Dr. SATTLER. Well, the Burlington Northern Railroad at this time has been improving its profitability. It is attempting to increase its operating efficiency. If they are able to do all of that, and if the economy rebounds so that they and all other railroads will have higher rates of return, then the railroad can more effectively compete with the natural resource divisions of the holding company and will probably not be hurt that much.

Senator BAUCUS. So in your view, one of the determining factors is the general health of the economy?

Dr. ŠATTLER. Well, that seems to have more of an impact on the railroads than it does the natural resource divisions. The railroad is an industry that is particularly impacted by swings in the economy. So that, yes, I would say that that has a significant impact on this.

Senator BAUCUS. Other than just general attention to management, what other factors can you think of that tend to point to whether a railroad, as in BN's situation, where it is in the middle of the scale of healthy to unhealthy, will growth healthier or less healthy, other than attention to management and other than the general economy?

Dr. SATTLER. Well, at this point, predicting what is going to happen in the next 5 to 10 years, and what is going to happen to the size of that profit gap is very difficult, because a number of variables are going to impact on that. But I would note Mr. Bressler's own statement, that financial resource divisions are going to expand significantly over the next few years. So if a railroad is going to continue to be successful in competing for funds, it had better stay profitable over the next 5 to 10 years. If it does not, then it is in trouble. At this point, I-and I do not think any economist can-cannot predict what is going to happen to the railroad industry over the next 5 to 10 years.

Senator BAUCUS. So if I understand you, you would anticipate that there would not be a rapid diversification into nonrail activities in the short run or in the middle term, that is, in the next 5 or 6 years; is that right?

Dr. SATTLER. Well, in the short run, I would not anticipate that the railroad would be harmed. Now, it is possible to diversify in the short run without hurting the railroad substantially. Typically, where the railroad gets hurt is over a span of 5 or 10 years, let us say, a track is undermaintained, and all of a sudden, the railroad finds, 10 years down the line, that the track is no longer operable. It is then no longer safe to operate at normal speeds and that destroys the operating characteristics of the railroad and hurts the railroad financially. So the potential for harm in this is really over the longer term.

Senator BAUCUS. Would you expect less capital to flow from the land grant assets to the railroads?

Dr. SATTLER. I would, because as Mr. Bressler points out in the annual report, all the divisions are operating on a basis of a profit center arrangement, which is to say that each division is responsi ble for generating its own profits. If it turns out that the resource divisions are in fact more profitable than "*

then they will get preferential treatment in terms of capital funds. So, yes, I would definitely believe that.

Senator BAUCUs. What kind of increased monitoring do you have in mind?

Dr. SATTLER. I was encouraged to note that the Interstate Commerce Commission appeared to be open to increasing the frequency of the monitoring and, hopefully, some of the detail of the monitoring of holding company transactions. I would particularly be interested in the Interstate Commerce Commission maintaining a very close watch on such things as the maintenance policy of the railroad. This is one of the avenues of potential disinvestment that was noted by the Interstate Commerce Commission as far back as 1970. So I would want them to look at the maintenance policy of the railroad; I would want them to analyze the operating characteristics of the railroads, such as the operating ratio; I would think that they should look at the dividends paid by the railroad to the holding company, and as well as fees paid by the railroad to the holding company, other avenues of potential disinvestment. In other words, we know from the theory and from practice that there are certain ways that assets are transferred from the railroad to the holding company, and we ought to use that knowledge to monitor these holding company/railroad relationships.

Senator BAUCUs. I appreciate that very, much. In fact, it would be helpful to this committee if you could, for the record, list the kinds of areas—and you have already done so in part-the kinds of inquiries and areas that you feel the committee or some appropriate agency should look at in monitoring holding companies.

Your reference to maintenance, I think, is critical. In my experience with the Milwaukee Railroad maintenance, the Milwaukee deteriorated long before the company made known its intentions to reduce its operations and also long before it became clear that the road was going into very difficult financial condition. That maintenance policy, I think, is very critical; I agree with you.

Dr. SATTLER. By the way, you mentioned the Milwaukee Road, and I would like to point out one thing. We should not be too fearful of the holding company in the sense that Mr. Martin went to quite detailed lengths to indicate that the Milwaukee Road was in trouble long before the holding company. I would agree fully that the Milwaukee Road was in financial trouble long before the holding company and the holding company only provided a vehicle to get rid of the railroad, to divest the railroad. A holding company is not necessarily the enemy here, if you want to think of it that way, but the problem is the low rates of return of the railroad. The holding company is not directly responsible for that, but it does provide a vehicle for the divesting of the railroad.

Senator BAUCUs. Thank you very much. We appreciate your testimony.

Dr. SATTLER. Thank you.

Senator BAUCUS. For the remainder of the afternoon, I am afraid we are going to have to restrict the presentations of each witness to 6 minutes. I am going to have a light system up here, and I think it will work this way, that for 5 minutes the green light will be on; when the green light goes out and the amber light goes on, that is 1 minute remaining; and when the red light goes on, well,

we will cross that bridge when we come to it. But I am going to be firm on this policy for one simple reason. Some committees tend not to be punctual. Airlines are punctual, and I am going home to Montana, and I have a flight to catch. So we will have to adhere to the 6-minute rule—although I probably will have some questions in addition.

Next, we will hear from Richard Kilroy, and Mr. Pat Foley.
Mr. Kilroy, why don't you begin?

STATEMENT OF A PANEL INCLUDING RICHARD I. KILROY, EX-
ECUTIVE SECRETARY-TREASURER, RAILWAY LABOR EXECU-
TIVES' ASSOCIATION, INTERNATIONAL PRESIDENT, BROTHER-
HOOD OF RAILWAY AND AIRLINE CLERKS, AND A VICE PRESI-
DENT, AFL-CIO, ACCOMPANIED BY WILLIAM G. MAHONEY,
COUNSEL TO RLEA; AND PATRICK J. FOLEY, ATTORNEY, DE
PARQ, ANDERSON, PERL, HUNGES & RUDQUIST, MINNEAPOLIS,
MINN.

Mr. KILROY. Thank you, Mr. Chairman. I appreciate the opportunity to appear here before the committee. We have submitted a statement, so I will not, of course, go into all of the detail of that statement, but try to just highlight it.

My name is Dick Kilroy. I am international president of the Brotherhood of Railway and Airline Clerks; a vice president of the AFL-CIO, and I am also executive secretary of the Railway Labor Executives' Association, which represents all of the rail unions as shown in the statement. I am also accompanied by Mr. William G. Mahoney, counsel to the RLEA, and I would ask that you please enter my complete statement in the record, and I will attempt to highlight it.

Senator BAUCUs. Yes, your whole statement will be included.
Mr. KILROY. Thank you.

The employees of the BN, whom our unions represent, are greatly concerned about the recent public pronouncements emanating from Burlington Northern Industries, some of which appeared in the March 8, 1982, edition of Business Week magazine, which indicate that company intends to use the corporate form of a holding company to milk the transportation profits from the Burlington Northern Railroad Co. in order to fund speculative resource development and oil company acquisition. If this course of conduct is permitted, it ultimately will prove detrimental to the physical plant of the BN railroad and its employment base, thereby directly affecting its employees. And it is the employees and the hundreds of small shippers who will suffer most in BNI's proposed venture as yet another publicly insensitive corporate giant propelled by but one consideration-the highest profit attainable, regardless of cost to the public.

It would seem the consideration owed employees and shippers in the case of the BN is intensified by the fact that through the action of the Interstate Commerce Commission, three transcontinental railroads-Great Northern, NP, and Milwaukee-were reduced to two, BN and Milwaukee, and then reduced to one, BN, with BN receiving operating rights and perhaps ultimately title to all the better lines Milwaukee was forced to relinquish. The BN Railroad