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I would like to put into the record a telegram received this morning from the secretary of the Illinois Commerce Commission, which is as follows:
SPRINGFIELD, ILL., April 4, 1985, John E. BENTON, General Solicitor National Association of Railroad and Utilities Commissioners,
Washington, D. C. Commerce commission has not as yet taken formal action with respect to H. R. 5423. Will advise you immediately when formal action is taken by Commission.
ILLINOIS COMMERCE COMMISSION,
WILLIAM W. HART, Secretary. I put that in, because it may perhaps be fairly interpreted that that commission has not yet determined whether the amendments which we distributed fully protect State power, or what position it desires to take.
BROOKLYN BOROUGH Gas Co.,
Coney Island, N. Y., May 2, 1935. Hon. BURTON K. WHEELER, Chairman Committee on Interstate Commerce,
United States Senate, Washington, D. C. DEAR Sır: In the interests of fairness and accuracy in your record of the hearings before your committee on the above bill, I write to ask that you cause the following to be inserted in the record of such hearings:
In connection with the statement made before your committee, in behalf of the pending bill, by Mr. Thomas G. Corcoran, counsel for the Reconstruction Finance Corporation, at the hearing held on S. 1725 on April 18, 1935, there appear the following references to the Brooklyn Borough Gas Co., in course of a discussion of the Associated Gas System (Mim. S. M. 247):
“The only variation that the Associated management has introduced into this appear the following references to the Brooklyn Borough Gas Co., in course of a discussion of the Associated Gas System (Mim. S. M. 247):
“The only variation that the Associated management has introduced into this method of increasing earnings without any additional investment in fixed capital is the expeditious manner in which the enhancement of valuation is achieved. Although in many cases actual engineering reappraisals have been made, often the management has not been satisfied with the meager results. It has adopted the much quicker method of charging to the fixed-capital account a flat increase of 45 percent of book cost. This is known under the euphonious name of 'Brooklyn Borough Overhead.' In 1926, a district court in New York allowed approxi. mately a 45-percent increase in the value of Brooklyn Borough Gas Co. capital. The Associated management took advantage of this liberality; with one fell swoop these overheads, to quote from the Federal Trade Commission's study, 'were applied by company offieials to all properties, regardless of the similarity of the property of their respective companies to the Brooklyn Borough Gas Co.'s property.
The above-quoted excerpt is part of an article entitled "Gas: A Study in Expansion, The Case of Associated Gas” by N. R. Danielian, which Mr. Corcoran put into the record (Mim. S. M. 232 et seq.), and which was made a part of the record despite remonstrance from one member of the committee (Mim. S. M. 261).
The quoted statement appears to leave the impression that the Brooklyn Borough Gas Co. is a part of, or is in some way identified with, the Associated Gas System. Such an impression is not in any way true, directly or indirectly, as to either ownership or management. The statement also creates the impression that the Brooklyn
Borough Gas Co. received, from the Federal Court in Brooklyn Borough Gas Co. v. Prendergast (16 Fed. (20) 615), a 45-percent increase in its capital structure or that the company had rewritten its fixed capital, on the basis of the court's findings, to the extent of a 45-percent increase. Such a statement or impression is wholly contrary to the facts.
The fixed-capital accounts of the Brooklyn Borough Gas Co., as they appear in its books of account, were determined as of 1914, on the basis of an opinion prepared by Commissioner Milo R. Maltbie and adopted by the Commission, following an inventory and pricing of the property embodied in the fixed-capital accounts. As of 1914, the company's books were rewritten by the company. under protest, to conform to the Commission's determinations. The fixed capital accounts of the company were reviewed in 1918
by the Honorable Charles E. Hughes, as referee in Brooklyn Borough Gas Co. v. Public Service Commission (P. U. R. 1918F, page 335; 17 N. Y. State Dept. Rept. 81); and the distinguished referee accepted and found the fixed capital accounts as determined by the Commission in 1914, plus net additions to date.
In the later action referred to in the above-quoted excerpt, the report of the special master and the findings of the three-judge Special Statutory Court of the United States for the Eastern District of New York (Brooklyn Borough Gas Co. v. Prendergast, 16 Fed. (20) 615) took and found the fixed capital of the company at the amounts determined by the Commission in 1914 and confirmed by Judge Hughes as referee in 1918, plus net additions at actual cost for the further period covered.
In finding the present value of the company's property (as distinguished from the actual investment therein) as of 1925, the master and the court included and allowed the elements of replacement cost according to law. This was only in connection with the finding of a "rate base" by which a confiscatory statute could be tested. It was not used, by the master or the court to anyone else, to allow “approximately a 45 percent increase in the value of the Brooklyn Borough Gas Co.'s capital.”
In adopting the master's report, the three-judge court stated (16 Fed. (20) at page 639):
The opinion and report of the special master deserves commendation for its careful consideration and analysis of the issues. We deem it unnecessary to add more than to say that his conclusions and reasons therefor meet with our approval.”
This company's books have never been rewritten, or its fixed-capital accounts added to or altered in any way, by reason of the findings of the master and court as to the 1925 value of the property for rate-making purposes. The company's books and accounts have been at all times kept in full compliance with the effective uniform system of accounts prescribed by the Public Service Commission of the State of New York.
I shall be grateful to you for causing this statement of the facts to be placed in the record of the hearings before your Committee. Very truly yours,
M. E. Dillon, President.
ASSOCIATED Gas & ELECTRIC SYSTEM,
Ithaca, N. Y., May 1, 1935. To the Members of the Committee on Interstate Commerce of the Senate of the United
States: GENTLEMEN: In accordance with your permission to file statements or exhibits with your committee, as part of its record in connection with the bearings on the Holding Company Act of 1935, we submit herewith an opinion by Herbert B. Dorau, Ph. D., associate professor of economics at New York University, setting forth his own views, as a student of public-utility economics, on the economic aspects of the proposed legislation. The following brief statement of Doctor Dorau's background, education, and experience is offered in the belief that it will be helpful to you in judging the weight which should be given his opinion is your consideration of the measure under discussion.
Doctor Dorau was born in Wisconsin received his preparatory education in the public schools of that State, and subsequently obtained his bachelor's degree from Lawrence College, Appleton, Wis., in 1919. He received the degree of M. A from the same university in 1928. He was assistant instructor in economics in the University of Wisconsin, 1920–23. In 1923 and 1924 he was research instructor in the Institute for Economic Research, Northwestern University, and was subsequently research associate (1925-29) and assistant director (1930-31) of the same institute. From 1925 to 1928, inclusive, he was also assistant professor of economics in Northwestern University School of Commerce and associate professir in the same school 1928–33. During 1929–33, however, he was on leave of absence from Northwestern University serving as economist with August Belmont & Co. Since 1933 he has been associate professor of economics in New York University. He was a lecturer on public-service corporations in New York University 1930-33.
Doctor Dorau is a consultant on business economics. He was a member of the President's Conference on Home Building and Home Ownership, 1931. He is a member of Phi Beta Kappa, the American Economic Association, and the American Statistical Association. In addition to contributions to The Journal of Land and Public Utility Economics, he has published the following works:
Real Estate Merchandising (with. A. G. Hinman), 1926
AssocIATED Gas & ELECTRIC Co.,
SOME ECONOMIC CONSIDERATIONS BEARING ON THE PLACE AND SIGNIFICANCE
OF THE HOLDING COMPANY IN THE ORGANIZATION AND FUNCTIONING OF THE PUBLIC UTILITY INDUSTRIES
An opinion by Herbert B. Dorau, Ph. D., Associate Professor of Economics,
New York University
The following analysis of the place of the holding company in the organization and functioning of the electric and gas industries represents in substance the conclusions freely expressed upon several occasions.
After reading substantial portions of the testimony presented for and against the Holding Company Act of 1935, it seemed unfortunate that more attention was not given to some of the more fundamental economic considerations. In the belief that the long-run consequences of the proposed or substitute legislation dealing with holding companies will be good or bad to the extent that it recognizes or fails to recognize such fundamental economic considerations, this opinion is offered, with the permission of the Committee, as a part of the testimony and record of the hearings on the Holding Company Act of 1935 before the Committee on Interstate Commerce of the Senate of the United States.
HERBERT B. DORAU.
I. REGULATION VERSUS DESTRUCTION
The holding company has proved to be, and still is, a useful legal-economic device for the most effective organization of the public-utility industries. Every good thing has been sooner or later abused. The holding company is not an exception. Because it has proved so genuinely and generally useful, the holding company may have been more abused than institutions of less consequence. The corporation itself, which is by many acclaimed as the most significant and useful legal-economic invention of man, while widely abused, is nevertheless on net balance accepted as a socially desirable institution. Progressive thought looks toward its perfection rather than its destruction. Continuous adaptation of such institutions to changing social needs and circumstances is the method of steady reliable progress, but to follow the cry for the destruction of all imperfectly functioning economic institutions can only lead to economic disorganization and decadence.
The issue between the desire to destroy and the need for regulation has rarely been more clearly drawn than in the proposed act to abolish holding companies in the electric and gas industries. In order to see this issue clearly, and not be confused by words and phrases, it must be understood that it is very easy also to destroy in the name of and by the method of regulation. To regulation, honestly and intelligently conceived to perfect the working of an economic institution, there should be no disintereste i objection. Destruction lowever, that needs to parade in the form of regulation is properly open to suspicion.
The holding company is a device which can and should be made to serve socially desirable economic ends more effectively rather than be destroyed or regulated out of existence. The method of abolitionism and prohibitionism has so frequently created more problems than it has solved that as a general principle it deserves little adherence.
II. THE PRIMARY FUNCTION OF THE HOLDING COMPANY In the broadest sort of way the holding company is a device for bridging the gap (a period of time) between the stage of industrially isolated plants and the stage of more or less complete industrial integration. Its peculiar usefulness is as an instrument for business combination where unified industrial operation is either, (1) not technically feasible or economical, or (2) is prevented by law.
The gas and electric industries are characterized by decreasing costs, incrensing returns, and thus the possibility of lower prices to the consumers. They are, therefore, industries where increasing size is accompanied by generally lover costs. The substantial and comparatively consistent decrease in the cost of electric service, even during periods of generally rising prices, is largely att-ibutable to the increasing scale of industrial and business organization.
In the first instance it is of course recognized that economies arise out of improvements in technology. Most of the improvements in technology were, however, limited in their most economical application to the large-scale undertakings. While economies of large-scale undertaking in the utility industries are well recognized by those acquainted with the technique of these industries, the fact is however frequently overlooked that these economies are of two distinct types:
1. Industrial economies: Those arising in the course of plant construction ani operation,
2. Business economies: Those arising in the course of business management as distinguished from industrial operation. Here would be included the economies of transactions-buying and selling, bargaining for capital, for materinls and supplies, and all relations with consumers.
It is well understood that in public utilities, as in other industries, the size and character of the market determines the economical size of the undertaking, i e, the size of the industrial establishment. It is thus obvious that a publié-utility operating company will have access to the economies of large-scale production in proportion to the size of the market which it can economically serve. Thus an operating utility controlling a large compact market will have substantial access to both (1) the industrial economies and to a considerable extent (2) the business economies which flow from large-scale organization.
By the same token, then, an operating utility having economical access to s small or thin market cannot have access to the industrial economies available to the large-scale undertakings. This handicap of the small electric market and the enterprise serving the small market was somewhat reduced in the years following the war by the building of transmission lines. Transmission and interconnection have progressively made some of the economies of large-scale centralized production available to the smaller market. The cost of transmission and intereonnection obviously stood in the way of passing all the economies of the large-scale central production on to the consumer in the smaller market. In fact it is probably true that interconnection in the electric industry has contributed more to improving the quality of the service than to reducing its cost. It is therefore probably also true that cost reduction for the interconnected, small, distant, maar kets is due more to the business economies that have been achieved by centralized management than to the economies of large scale central production which remained after deducting the cost of transmission and interconnection.
There are thus two ways in which an operating utility controlling a small tattet may secure access to the economies of large establishments.
1. Secure some of the industrial economies of large-scale production by distributing electricity or gas produced under the more economical conditions of large scale centralized production.
2. Secure the business economies of large establishments as part of a holdingcompany system or under contractual arrangements with large-scale management firms. The latter alternative is obviously incomplete since it cannot offer the economies of large-scale financing with diversified risk.
Public utilities differ markedly from industrial concerns in their economic characteristics. It is largely because of these differences that the bolding company has served a more necessary and useful purpose in the organization of the utility industries than in other classes of industries. It is to be noted that industrial concerns, producing more or less readily transportable products, can, within large limits, choose the size of the market within which to operate. The size of the market which they can establish determines in a large way the profitable and economical size of the undertaking. Industrial concerns, moreover, are not limited by franchises and political boundaries. In contrast, public utilities are far more limited in the profitable and economical size of industrial plant by the natural factors of distance and area.
The electric and gas utilities have been called “local service industries.” The scope of "local" has however changed materially. It is a simple matter of observation that where the market is substantial and uniform over a wide geographic area this local service industry may cover territory several hundred miles in extent. Similarly there are large portions of the United States where markets for utility services are small and separated by long distances in which little or no demand for the services exists. Accepting the dictionary definition of “local", these industries are and are not local service industries depending upon the economic character and size of the market for their services. Much of the testimony in favor of the Public Utility Holding Company Act of 1935 has emphasized the fact that these industries were local industries. Insofar as this testimony accurately represents the fact it is the most effective argument in favor of the retention of the holding company. To the extent that this local industry is industrially small scale it does not have access to economies of production for larger markets. But these circumstances, largely natural in character, need not however bar the smaller market from the benefit of all the economies available in the larger markets. The business economies of large-scale undertakings can be brought to the smaller (local) markets through the facilities of the holding company.
The Holding Company Act of 1935 appears completely to have overlooked this fundamental economic basis for the existence of holding companies. This legislation proposes "eliminating therefrom (holding companies) properties not economically and geographically related in operations." Whatever may be meant by “economically related" certainly the reference to "geographically related" indicates a lack of understanding of the place and service of the holding company.
The absolutely contrary view is here offered, namely that the special function of the holding company is to unite in a business way those operating utilities which are not geographically contiguous and which are therefore not economically integratable on an industrial or operating company basis. Incidentally, it may be pointed out here that there are some useful ends to be gained by not having one company control all the service in a given territory, particularly where this does not involve sacrificing the substantial economies which could be obtained by physical integration. Such is not infrequently the case outside of the more densely populated territories. Some division of ownership and management, under these circumstances, may indeed introduce a desirable form of service competition in an industry where other competition generally is so wasteful and therefore properly avoided.
If the foregoing constitutes a sound analysis of the place and function of the holding company in the public-utility industries, it must also be recognized that the significance of the holding company is less as these conditions disappear. Increases in the size of operating utility companies decrease the significance of the economies which can be obtained in association with a holding company. This does not mean that operating units would necessarily reach the point where a holding company could not be of some, or even material, service, particularly in matters involving broad managerial policies and above all the provision of equity capital. There are already instances at hand where the holding-company form of organization has been superseded by the unified operating company after the market and territorial development justified this step. There are other weil known cases where operating company consolidation would undoubtedly take place if the laws of the State or the provisions of franchises permitted this natural tendency to work itself out.
The question is often asked, How large must an operating utility become before it can by itself have access to both the industrial and business economies of large scale production? The answer seems to be that this depends on the nature of the business transactions involved. Some holding companies, whose subsidiaries are small operating units, have found it economical to handle billing and accounting and in fact almost every business activity of their subsidiaries.
This would appear quite justifiable where operating properties were very small. In other cases, where the operating properties were large and where they are apparently able to carry on most of their routine business transactions for themselves it was nevertheless found that the holding company could most economically perform certain financial functions such as providing increased equity capital. In general the trend has been for the operating unit to do more and more for itself as it grew in size. It has been noted that holding companies whose subsidiaries were small tended to perform a great variety of functions while holding companies