TABLE 4
Selected Data on L & N Railroad During the Period, 1894-99
Sources: Henry V. Poor, Manual of Railroads (New York, 1900), 420, 422; Commercial and Financial Chronicle (October 8, 1898), LXVII, 714.
Inevitably the financial policy of the new administration dated from the 1884 issue of 10–40 adjustment bonds on sacrificial terms. Although the sale of these bonds and an equal amount of treasury stock brought probably the worst prices in the company’s history, it enabled the L & N to weather the crisis and restore its credit to good standing. The new board learned its lesson well and resolved to pursue a conservative course. For four years the board paid no dividends and applied all earnings to construction, maintenance, sinking fund payments, and other financial obligations. When some foreign stockholders clamored for dividends in 1888, Norton and his advisors resorted for a time to the then uncommon device of paying stock dividends. Not until 1891 did the L & N resume full cash dividends.
If the bankers had had their way, the company might have followed its cautious policy for years. The problem was that their course conflicted sharply with Smith’s approach to management and his strategic designs. Smith fully approved a conservative financial policy, but he defined the term somewhat differently. Immersed in a sea of strategic and operational problems, he needed money to increase his equipment and facilities, to construct important extensions, and on occasion to buy feeder lines or annoying rivals. He was willing to eschew dividends for as long as necessary but deemed it prudent to borrow whatever amounts were needed for strategic and operational purposes. Though Smith’s approach would occasionally give rise to a troublesome floating debt, he believed that the long-term advantages would far outweigh that drawback.
As suggested in the last chapter, Smith assumed that basic strategic decisions were essentially his domain. If the course he decided upon cost money, it was up to the bankers to supply it. As Mary Tachau put it, “His relationship with his Boards was essentially a foedus inter pares: they were to provide a sound and adequate financial base, and he would protect their property.”1 Implicit in Smith’s argument was the belief that everyone concerned was working for the same objectives and would therefore approve his methods and concur in his strategic decisions. Unfortunately this was not the case. Both Smith and the bankers were vitally interested in the company but from slightly different vantage points.
Having made the L & N his life’s work Smith viewed its development in long-range terms and so assigned that task priority over any other considerations. In contrast the bankers naturally saw their role as a protective one. They were interested in the company not for its own sake but as business for themselves and an investment for their customers. This caused them to take a more short-term view of the system’s development. Any worthwhile investment had to pay dividends, and their job as protectors was to insure that the L & N did just that. Once the company’s financial condition was stabilized, expenditures for development would have to be balanced against a reasonable return to the stockholders. Any lengthy delay of dividend payments would discriminate unfairly against those holders who got no income on their shares and, for whatever reason, sold their stock before the funds plowed back into development reaped a profitable return.
This difference of perspective, subtle but crucial, accounts in large part for the persistent tension between Smith and the bankers. Smith believed that the system and its needs were paramount, that it would outlive any of its owners and therefore transcended their immediate needs, and that the stockholders were obligated to provide anything necessary for its survival and success. To be sure he dutifully acknowledged his responsibility to the holders but was quick to reaffirm their responsibility to the company. In practice he probably cared very little for the faceless holders of engraved certificates denoting part ownership in a corporation. He was, after all, a railroad man. The L & N’s destiny was largely a monument to his creative genius if he did his job well. Monuments outlive men; why should he cater to the transient demands of those who understood nothing about the railroad and wanted only profit? In that sense Smith was very much a modern manager: he was employed by and devoted to a corporation, not other men. Too often he tended to view the bankers not as associates but as obstacles to the important work at hand.
Needless to say, the bankers resisted Smith’s perspective vigorously. They shared his integrity and devotion to duty but not his creative drive or monomania. They were “practical” men with far-reaching interests and responsibilities. They had to consider all facets of the situation and could not afford to let Smith build his monument unsupervised. They reasoned that if Smith were allowed free rein, the L & N might prosper and flourish but the stockholders would pay for its success with no income. That might be a genuine creative achievement but it was not good business. For that reason they clung tenaciously to the purse strings, releasing funds for capital expenditures only when Smith fully convinced them that the investment was sound.
During the late 1880s, when crops were good and general business conditions encouraged expansion, some of the bankers joined Smith in urging substantial investments in developmental projects and to absorb select competitors. The ensuing divisions within the board shifted steadily towards Smith’s position until the ill financial winds of the early 1890s began to blow. When the full force of the Depression hit, however, the scales swung sharply in the opposite direction even though a prolonged controversy over specific projects kept the board fragmented. In good times or bad, the debate over proper financial policy never lost its intensity.
The results of operations in 1884 and 1885 did little to encourage the new administration. While the company struggled to regain its financial equilibrium, nature dealt it one costly blow after another. The wheat crop in Tennessee, Kentucky, and Illinois was short in 1884 and failed almost entirely in 1885. Corn also failed, and the quality of cotton was so inferior that it brought extremely low prices. The first half of 1885 witnessed a continual round of calamities. Unusually cold weather and heavy snows interrupted traffic, required large numbers of extra employees, and led to frequent accidents and casualties. A serious accident on the South & North Alabama shut down all through traffic from January 8 to January 12. A great flood in the Alabama River Valley closed down the South & North and the Montgomery & Mobile completely from March 28 to April 26, a total of 29 days. During that same period the main line had to surrender all through business south of Montgomery. The Lebanon extension (now called the Knoxville branch) was seriously damaged by floods, and traffic on the Memphis branch was interrupted for ten days. A sudden rise in the Barren River on May 8 swept away part of the trestle of a new bridge and stopped traffic for three days.
Nor was that all. A strike by switchmen in East St. Louis caused a cessation of through traffic on the St. Louis division from March 9 to May 4. The switchmen at Evansville also struck and disrupted cargoes to that locale. Late in January the freight depot in East St. Louis and the company shops in New Orleans both went up in flames, as did the freight depot in Russellville on May 15. These catastrophes, combined with a generally poor business climate, seriously reduced the L & N’s earnings. Gross earnings on the system, which had risen to $14,351,093 in 1884, fell off to $13,936,346 in 1885 and $13,177,019 in 1886. Net earnings were maintained in 1885 partly by keeping expenditures to a bare minimum, but even this policy could not cope with the disasters of that year. On January 12, 1886, Smith predicted privately to the board that net earnings for fiscal 1885–86 would decline about $750,000 from the previous year; the actual drop proved to be $790,368.
These figures presented the board with a grim backdrop for their efforts to heal the company’s financial wounds and restore its credit. The sacrifice of the 10–40 bonds and treasury stock had staved off immediate disaster and reduced the floating debt to manageable proportions, but a workable financial policy remained to be developed. Obviously it would be a conservative policy, but there were many directions such an approach could take. Since the resumption of dividends would bolster the company’s credit and the price of its securities, the board could rigidly cut back expenditures for all purposes and pay all surplus earnings to the stockholders. Or it could abstain from dividend payments and use surplus earnings to reduce outstanding obligations. A third possibility would be to pour surplus funds into carefully selected developmental extensions and improvements. This approach would broaden the income base, upgrade service and equipment, and restore the L & N’s competitive supremacy. In long-range terms it would presumably provide the soundest foundation for dividend resumption.
Each of these options had its advocates within the L & N management, which meant that none would be chosen as the sole basis for financial policy. The first promised the most immediate results and would unquestionably please the stockholders. But it left no margin for developing the system and might even allow facilities to deteriorate or at least fail to keep pace with growing needs. The same objection could be made to the second course, which had the advantage of paring fixed costs as rapidly as possible. This approach, however, would be undermined by any developmental programs that incurred new obligations. The third option best suited the changing needs of the system itself and allowed the greatest flexibility. The drawback was that it asked the stockholders to make continuing sacrifices, to forego any income on their shares with no assurances that the developmental strategy would prove successful. They just might wait forever for profits to return. Some might lose heart or dispose of their shares out of necessity and thereby gain nothing for their sacrifice if and when dividends did resume. Whatever its merits, this approach would be hard to sell to security holders.
During the next decade the contours of the L & N’s financial policy evolved from a perpetual tug-of-war among advocates of these three alternatives. The tugging commenced in May, 1885, when the board allowed Kuhn, Loeb to surrender their option on the last $2,000,000 in the 10–40 bonds and placed them instead with Halgarten & Company at 66¼. As the credit crunch eased and the price of the bonds rose steadily, the board decided to reacquire a like amount of the securities and reduce its obligations to that extent. In September Smith asked that the remaining surplus be applied to extending the Birmingham Mineral road (see Chapter 13), but the board voted instead to use the money for a dividend. Later it reversed the decision on declaring a dividend but still did not give Smith the money he wanted.
Thwarted but not discouraged, Smith hammered away at the board to adopt the third option as a basis for financial policy. In September, 1886, he recalled for the board the measures he had proposed in 1883 to put the system in order: the replacement of all iron on main lines by steel rails; large expenditures for ballast; a substantial addition to rolling stock including new engines; a major program in road and bridge repairs; and a change of the entire system to standard gauge. Of these proposals only the last one had been carried out, and that was done two years after Smith’s recommended date of completion. He urged anew that provision be made for these needs as well as for a selective but aggressive program of developmental extension. His vigorous presentation got some results. During fiscal 1886–87 the company expended $1,328,963 for extension work on several branches, built a new passenger depot in Birmingham, spent $129,760 for ballast (an increase of $91,972 over the previous year), added some new steel rail, and stepped up bridge repairs. In each case Smith got less than what he wanted, especially in the area of rolling stock. Freight cars increased from 10,009 to 10,827, but the number of locomotives, passenger cars, and service cars actually declined slightly.
These expenditures were possible because the business climate grew progressively more favorable. Gross earnings rose from $13,177,019 in 1886 to $15,080,585 in 1887, and net earnings from $4,963,723 to $6,033,531. This general upswing continued through 1893. While this pattern might seem at first glance to favor the policy Smith advocated, it actually had the opposite effect in that it stimulated the appetite of the stockholders for dividends. All three options assumed an annual surplus and differed primarily on how best to dispose of it. The stockholders’ demands could easily be dismissed when a deficit occurred simply because there was nothing to divide. When operations began to show a sizable surplus on a regular basis, however, it was hard to fend off the shareholders with even the best of developmental arguments.
The tugging over dividends commenced in earnest in January, 1887, when some directors advocated a semi-annual declaration. In the heated debate that followed, Norton supported Smith’s position and managed to carry a majority of the board with him. He was equally successful six months later but felt obliged to note in the Annual Report that
Although last year’s earnings have been very satisfactory, it was deemed best not to declare any dividend, as the necessity for the extension of branches, and for new equipment to meet the requirements of increased business, made it desirable to keep your company in a strong financial position.
If the earnings should continue as at present, which the new industrial developments promise, your Directors hope to employ such part of future earnings for dividends as the position may warrant.2
That vague assurance was not enough for some of the stockholders. Recognizing that they could not attack the board’s conservative policy outright, a group of the London holders devised an ingenious alternative. In January, 1888, they petitioned the board, praising its conservative approach but asking approval for the following plan: that all surplus earnings for three years continue to be used for betterments, and that during the same period the shareholders receive a dividend in stock equal to the amount of the net surplus so used. This would enable the company to devote its full resources to development while appeasing the demand for dividends. A committee appointed by the board reported favorably on the petition, and the directors voted a 2 per cent stock dividend subject to approval of the plan by the stockholders. At a special meeting for that purpose, held on February 21, 1888, the new policy was endorsed 168,392–4,112.
In both 1888 and 1889 the L & N paid 5 per cent dividends in stock. The following year Norton declared dividends totalling 4.9 per cent in stock and 1.1 per cent in cash, and thereafter the company resumed cash dividends. In 1889 he praised the stock dividend policy as enabling the system to improve its physical condition and virtually pay for the betterments with common stock at par. “Had a different policy obtained,” he added, “and had cash dividends been declared for the past two years, the Company would have been compelled to borrow money, by the issue of securities, to pay for amounts due for capital account.”3 The Commercial and Financial Chronicle applauded the policy because it was sound and also distributed dividends to those deserving of them:
That is a precedent which, even if widely followed, can harm no interest.… The kind of stock dividend that is wrong is one made, not when earned, but after allowing these surpluses to accumulate from year to year until the item becomes a large one and until those who were owners of the company when the profits were earned in part are owners no longer. Such sporadic dividends are neither just nor in the interest of public morals. They are not just because … the stockholders are constantly changing, those in possession when the distribution takes place not being entitled to it; they are harmful to public morals because they are the basis of a wild speculation, those only making the money who are the managing trustees of the property and their friends having inside information.4
The Chronicle’s assessment, a fitting epitaph on an earlier period of the L & N’s history, suggested just how far the company had come in its restoration work. In 1889 Norton and the other bankers were prepared to take the L & N a step further. At that point the company’s securities were all commanding good prices. Its stock had climbed steadily toward 80, the 10–40 bonds were quoted at 104 bid, and the collateral trust sixes issued by Baldwin in March, 1882, were selling above 110. At the annual meeting on October 2 Norton proposed that the company issue $13,000,000 in new stock for the sole purpose of redeeming the 1882 collateral trust bonds and certain other interest-bearing obligations.
The conversion of debt into equity, a project long urged by Jacob Schiff, had few precedents among southern roads and none on so large a scale. Some $538,000 of the $10,000,000 had already been retired by the sinking fund established for that purpose. The annual interest on the remaining $9,462,000 was $566,000, and the sinking fund required another $100,000. The savings obtained by cancellation of these payments through conversion would be equivalent to nearly 1.5 per cent on the company’s stock including the proposed issue. Norton explained that this saving would enable the L & N to resume the payment of cash dividends. His plan won approval by the overwhelming margin of 232,560–55. Despite some skepticism about the L & N’s ability to dispose of so large an issue in a weak market, the sale went smoothly, realizing a total of $11,050,000 at an average price of slightly under 85. Nothing better illustrated the company’s reinvigoration than the success of this operation. Schiff marvelled at the transaction:
It is amazing with what readiness, in spite of the otherwise unfavorable situation of the market in general, the $13,000,000 of stock have been absorbed, and it is a proof of the great confidence which is generally felt in the administration and possibilities of the Louisville.5
Despite their unanimity on this question, the board soon lapsed into disagreement over other important issues. The business climate appeared to some of the bankers, notably Schiff, to be shifting toward troubled times and they strongly urged a cautious approach to all questions. Smith insisted that certain strategic extension and expansion projects had to be undertaken without further delay, and that the program of improvement expenditures should be stepped up. More than once he won Norton and a majority of the board to his side. Norton was, in fact, ready to present his own solution to the financial debate. Noting the necessity for expansion and improvement funds as well as the wide variety of outstanding obligations on the L & N, many of them at high interest rates, he suggested in 1890 that everything be refunded through a Unified Mortgage.
Specifically he proposed issuing 50-year 4 per cent gold bonds totalling $75,000,000. Of this amount $41,917,660 would be reserved to retire prior issues, several of which were expiring in the 1890s. The remaining $33,082,340 would be expended for such purposes as branch extensions, acquisition of other roads, and improvement expenditures. Norton argued that the Unified Mortgage would have a vast advantage over the old practice of issuing divisional or branch bonds for each extension built. All would carry the L & N’s name and therefore be familiar to the investing public, which was not the case with some of the branch bonds. In addition, many of the latter securities were issued in amounts too small for broad public sale, which meant that reliable market quotations on them could not be obtained either in New York or in Europe. The unifying of all obligations would avoid “the difficulties and the unnecessary expense arising from the frequent issue of bonds under names not yet favorably known to the public.”6
Despite objections from Schiff, Norton formed a syndicate including Swiss and German bankers in July, 1890, to handle the first $3,000,000 of the new bonds. The syndicate began to market the bonds in October, but less than a month later a major financial crisis in Argentina seriously disturbed the London market and sent tremors through all the leading money markets. Despite the company’s solid credit standing, Norton found it difficult to dispose of even the L & N bonds under such conditions. The deteriorating financial situation aroused the more conservative bankers like Schiff to argue that more earnings be laid aside for contingencies, that some major acquisitions then under consideration be tabled for the time being, that no more bonds be issued until financial conditions improved, and that the floating debt be curtailed.
Norton and a majority of the directors followed some of Schiff’s advice, but they took a more sanguine view of business conditions. Over Schiff’s objections they prepared a second batch of Unified Mortgage bonds for marketing. The issue was disposed of successfully, but the methods used by the board so antagonized Schiff that he considered resigning. Late in January, 1891, he introduced a resolution stating that before any new commitments were made, the finance committee should make certain that the necessary funds could be raised without resorting to short-term loans. Schiff deemed this resolution essential to curtailing the floating debt, and he was prepared to leave the board if it did not pass. The resolution carried, but Norton’s basic approach did not change. The board declared a 2.5 per cent dividend in January, Smith pressed incessantly for money for improvements and extensions, and the floating debt crept up steadily. On February 10 Schiff complained to a close friend that,
It is true that thus far, through a conjunction of favorable circumstances, Norton has apparently been successful in the administration of the Louisville & Nashville, but other times will come, and then the whole board will bear the moral responsibilities for his errors. Mr. Loeb thinks that until this controversy … is settled, I ought not to resign, and after considering the matter very carefully, I believe I shall follow his advice. Nevertheless, I think it best, at the first favorable opportunity, to give up a connection which has brought me little pleasure and will, I believe, bring me little in the future.7
The very next day a clash with Norton prompted Schiff to offer his resignation. Norton hastily replied that he had already decided for personal reasons to leave the management himself and urged Schiff to withdraw his resignation. Schiff did so and promptly took the lead in proposing that a chairman of the board be named who would have final authority on all important financial questions. Schiff hesitated to support Belmont for the position because he wanted a man who could devote his full attention to the L & N’s affairs. But he admitted that such a man was difficult to find, that Belmont was “very intelligent and conservative, and desirous of doing the right thing,”8 and that he might be able to secure for the L & N the financial support of the various Rothschild houses.
His appraisal proved accurate. Belmont’s accession strengthened the hand of the more conservative directors. His cautious demeanor came at a good time, for financial conditions went steadily downhill. In February, 1891, the L & N attempted to clean up its floating debt by marketing some of the Unified Mortgage bonds, but the effort failed. A contraction of the market was already underway, and American houses were being forced to repurchase American securities in Europe. Under these conditions Schiff was firmly convinced that the L & N should retrench. On March 5 he offered a resolution that no new construction or improvements should be undertaken at the present time. This was the same issue on which he had clashed repeatedly with Norton and Smith, but this time the measure carried unanimously.
The floating debt problem persisted. Mindful of the market’s reluctance to absorb new bonds, Schiff in June advocated a sale of new stock to wipe out the floating debt. The board approved an issue of $4,800,000 and Kuhn, Loeb agreed to handle arrangements. The stock was first offered to current holders, who could purchase an amount equal to 10 per cent of their holdings. The asking price was 70 at a time when the market price stood at 75%. The sale eased but did not solve the debt problems. Meanwhile conditions grew worse. Several roads began to suspend dividend payments, and in the South, where few roads paid regularly, the L & N naturally attracted national interest every six months. Surprisingly, gross earnings rose steadily to a peak of $22,403,639 in 1893. Net earnings, except for a slight dip in 1891, did likewise, reaching $8,020,997 in 1893. Despite their apprehension about the future, the board declared cash dividends of 5 per cent in 1891, 4.5 per cent in 1892, and 4 per cent in 1893. But the handwriting was on the wall: development had virtually ceased, and dividends could not be far behind.
Both gross and net earnings reached their highest levels in the company’s history during fiscal 1892–93. By the summer of 1893, however, it was already apparent that a major business depression was in the offing. The L & N was especially sensitive to the severe slump in the iron industry since it was primarily a mineral rather than a cotton road. Thus, the extraordinary cotton crop of 1894 buoyed the earnings of many southern roads while the L & N slumped sharply to $18,974,337 gross and $7,110,552 net. Sensing that the decline was not temporary and that the future remained uncertain, Belmont, Smith, and Schiff agreed upon a broad program of retrenchment including sharp reductions on expenses, the cessation of dividends, a tight rein on the floating debt, the continued conversion of debt into equity where possible, the refunding of outstanding obligations at lower rates, and a revision of the company’s accounting procedures.
On August 15, 1893, the board resorted to the traditional expense-saving device of cutting wages and salaries. The provisions affected officers as well as laborers. All salaries above $4,000 were slashed 20 per cent; in addition the second vice president had his expense account pared from $3,000 to $1,500. Salaries between $4,000 and $600 would be reduced 10 per cent but no salary after this cut was to exceed $3,200. Those wages below $600 were affected only in that none could exceed $540. The directors’ salaries were also cut 10 per cent, and Belmont and Smith agreed to waive their compensation as directors entirely. All reductions were made retroactive to August 1.
Despite every effort at retrenchment, the slump in earnings created a sizable operating deficit at a time when the money market was fast tightening. Predictably the board divided over the question of how best to meet short-term needs. In September the board agreed upon issuing $5,000,000 in new stock. Schiff suggested that, given the weakness of the market, the shares could be used as collateral for short-term loans during the next six months, if the lenders were granted preferential purchase rights. But L & N stock, which opened the year at 77⅜, dropped steadily to a low of 39% in December. Unwilling to launch the shares into a falling market, the board considered the possibility of issuing another batch of the Unified bonds. Smith favored the idea and Belmont supported him, but Schiff objected to any increase in the fixed charges and refused to involve his firm in any bond issue. As he explained to Belmont on October 16,
It is true, when the board decided upon the issue of new stock, it was expected that the creation of further floating indebtedness could be avoided, which expectation it is now, with the recent heavy decline in the market price of the stock, not possible to realize.… Even now I would again and again vote for an increase in the company’s capital stock, rather than see its fixed charges further permanently increased. … I could therefore not conscientiously cooperate in the sale at this time of an additional amount of Unified Bonds, even if the market were in a condition to absorb more bonds, which it is not.9
Three days later, at a board meeting to consider the problems, a resolution was introduced authorizing the chairman to sell Unified Bonds at 70 or, if sale was impossible at that price, to borrow $1,500,000 for one year at rates not exceeding 6 per cent plus 2.5 per cent commission. Belmont joined Schiff in opposing the plan, but it passed by a 7–2 vote. None of the Louisville directors, including Smith, were present to vote on the measure. For the next two weeks Schiff urged a compromise plan upon the board: leave the bonds in the treasury, use them to secure a fairly long-term loan, and sell the new shares to liquidate the loan as soon as the market perked up. Eventually the board did follow a version of his proposal, but Schiff’s influence was ebbing. On the very day the bond resolution carried, Schiff confided to a friend:
In view of the policy now established, I personally can remain on the board only so long as is required by your interests, and, secondly, our own.… Although there is no immediate danger in prospect, … I fear nothing pleasant can come of it when pecuniary and moral engagements are made on a constantly rising scale.10
Two weeks later he resigned as director after a disagreement with the board over a related issue.
Schiff’s departure left Belmont as the most influential banker promoting conservative policy on the board. As the Depression deepened, he found his board more amenable to pursuing cautious policies. The result of their careful work, combined with Smith’s firm grip on operational matters, was to have lasting influence on the L & N’s destiny. The obvious next step was to eliminate dividends. The board announced in January, 1894, that it would pass the semi-annual dividend. The stock trembled a bit at the news but soon regained a firm footing in the middle 40s. For five years the L & N paid no dividends, a pattern that could have been interpreted as a sign of weakness had it not been accompanied by other vigorous actions.
During the next two years the board undertook several major revisions of the L & N’s accounting procedures. First and foremost, it closed the construction account as of July 1, 1894, and thereafter charged all expenditures for improvements and extensions (except outlay for new lines) to operating expenses under the subheading “Improvement Account.” This change represented an important shift in policy. In the past the construction account was charged directly to capital account and became part of the floating debt. By charging such expenditures against income, the board reduced the interest burden of the floating debt, tied improvements directly to earnings, and in effect made them a prior claimant (ahead of dividends) upon the surplus.
It was a very conservative policy and it did not sit well with some of the English stockholders, who believed, as the Chronicle put it, “that every dollar earned should go to the stock.”11 By cutting directly into income, the new policy most assuredly lessened the chance of a dividend being paid. Smith strongly favored such a course because it maintained the system at a time when it was tempting to let upkeep slide, and the board backed him. During the five-year period 1895–99, the L & N applied $2,621,230 of its earnings to improvements and construction.
To foster a more accurate picture of the company’s true worth and to squeeze any remaining water from its stock, the board introduced several other new practices. First, it reexamined all of its dubious assets and accounts for the purpose of charging them off. These items ranged from long-standing advances to roads like the South & North Alabama, which would probably never be repaid, to worthless and uncollectable accounts such as Baldwin’s remaining obligations. A total of $1,668,956 was written off to profit and loss in 1894. The following year only $114,948 was assigned to profit and loss while $697,669 was charged directly against income. In 1896 profit and loss was debited $47,739 for uncollectable accounts and an astounding $114,275 for a reduction in the valuation of the main office. Thereafter the practice continued on a regular basis.
These actions conveyed to the public a seriousness of purpose in rendering the company’s accounts on a strict basis, but the board went even further. Beginning in 1895 it charged against income the difference between sinking fund payments and the market value of the securities received for the various funds. During the five-year period 1895–99 this charge amounted to $764,856. At the same time the board decided to charge against income the discount on its bond sales. Rather than wait until the bonds matured, the proportional yearly amount was assessed so as to liquidate the discount by the time the bonds expired. The charge against income for this purpose totalled $117,515 during the same five-year period. Finally, the board in 1896 altered the traditional practice of charging the interest account with coupons only as they matured. It elected instead to list all interest accrued to June 30 (the end of the fiscal year) but not due until subsequent months as a liability on the general balance sheet. This meant charging profit and loss for the accrued interest, and in 1896 alone that figure amounted to $733,877.
Conservative financial circles applauded the company’s rigorous accounting reforms. The Chronicle stated approvingly in 1898 that “The L. & N. management may indeed be said to have been one of the first to see the drift of things in the railroad world and to become impressed with the need of abandoning old, conventional policy and substituting for it a new and enlightened policy more in accord with the needs of the day.”12 At the same time the board attempted to pursue its avowed refunding policy on maturing obligations. This was no easy task in a depressed market. The objective was not only to refund fixed charges at a lower rate, but to do likewise for as much of the floating debt as possible.
In August, 1895, the company managed to place $2,000,000 in Unified Bonds and a new $4,000,000 issue of 4.5 per cent bonds on the Mobile & Montgomery. This sale enabled Belmont to call in the 10–40 adjustment bonds on February 1, 1896 and pay off $825,000 on due bills. Redemption of the outstanding $4,531,000 in adjustment bonds was a significant step, since it released $9,283,000 in various securities deposited as collateral. Of this amount, $2,677,000 consisted of 6 per cent Mobile & Montgomery bonds which were immediately redeemed by the new issue on that road. The remaining securities were put in the treasury and scrupulously added to the company’s funded debt. The result of this transaction was both to increase the L & N’s outstanding debt from $79,158,660 in 1895 to $86,724,660 in 1896 and to decrease its interest payments. This seeming anomaly arose from the fact that the L & N sharply increased its holding of bonds in its own treasury (on which it paid no interest) from $2,861,000 in 1895 to $12,301,000 in 1896. Of this latter amount $5,680,000 consisted of Unified Bonds for which the board had not found a suitable market.
Despite every effort at operational and financial economy, the floating debt resisted every attempt to subdue it. In addition, two major portions of the funded debt, totalling nearly $10,000,000, were scheduled to mature in 1897 and 1898. Since both had originally been floated at 7 per cent, the board seized the opportunity to refund the issues at lower rates and also to strike a blow at accumulating bills. The first security, a first mortgage on the Louisville, Cincinnati & Lexington, was redeemed by converting general mortgage bonds on the same road from 6 to 4.5 per cent. The new issue, totalling $3,258,000, had originally been part of the collateral for the adjustment bonds and was being held in the L & N treasury. A syndicate of three houses headed by Kuhn, Loeb handled the transaction.
A second security, the consolidated mortgage of 1868, was due for redemption on April 1, 1898. To refund the $7,070,000 still outstanding, Belmont resorted to some nifty shuffling. The Unified Bonds were bringing little more than about 85 on the market. Unwilling to let them go at that low a price, the board arranged instead an issue of 4 per cent 5–20 collateral trust bonds totalling $12,500,000. These were secured by a deposit of $14,000,000 in Unified Bonds and $4,000,000 in bonds on the newly acquired Paducah & Memphis division. From the proceeds of this new issue Belmont retired the consolidated mortgage sevens, reimbursed the L & N for the cost of the Memphis & Paducah, paid off the floating debt, and left about $2,000,000 cash in the treasury. For the first time in years the management could report that the company was “entirely free from floating debt.”13 More important, this arrangement left Belmont the flexibility to substitute the Unified Bonds for maturing obligations when their price improved.
The combination of these policies produced a remarkable record for a railroad combatting a major depression. As Table 4 shows, the board succeeded in hammering down interest payments despite the hard times and tight financial market. Much of the rise in funded debt involved not new obligations but primarily changes in the road’s accounting system and a sharp increase in treasury holdings. Total fixed charges rose slightly for similar reasons: a revision of accounting procedures, additional payments to the weaker auxiliary roads, and increased taxes. On the latter point, the L & N paid $735,330 in taxes in 1899 as opposed to $600,359 in 1894. Most impressive of all, the company garnered a surplus after all charges against income every year of the Depression. Not even the strict new accounting methods could conceal that fact. Contemporary observers joined the board in attributing that happy result to the twin policies of refunding and not increasing the debt for improvement outlays.
TABLE 4
Selected Data on L & N Railroad During the Period, 1894-99
Sources: Henry V. Poor, Manual of Railroads (New York, 1900), 420, 422; Commercial and Financial Chronicle (October 8, 1898), LXVII, 714.
Part of the L & N’s enviable record could be explained by the contributions of its largest subsidiary, the Nashville, Chattanooga & St. Louis. On the surface that system scarcely seemed affected by the Depression even though mineral ores normally comprised over 20 per cent of its traffic. The onset of Depression, coupled with a costly strike, sent gross earnings tumbling from $5,131,779 in 1893 to $4,521,662 in 1894. Rigid economy held the decline in net earnings to only $141,892 for the same period, and thereafter gross and net earnings climbed steadily. Throughout the Depression years the Nashville paid dividends regularly. The company had been declaring 5 per cent payments since 1889. The turmoil of 1894 caused the directors to skip the August declaration and thereby pay only 2.5 per cent for the year, but from 1895 to 1898 the road paid 4 per cent annually.
The role of the L & N’s management in shaping the Nashville’s dividend policy is hard to determine. The L & N, of course, held a majority of the Nashville’s stock and could formulate policy as it chose. Since it received most of the Nashville’s dividend payments, the temptation to rely upon the subsidiary road for regular income may have been irresistible. On the other hand, the Nashville possessed a reputation for independence, and Smith testified more than once that it even competed with the L & N for traffic. To be sure he exaggerated the genuineness of that competition, but his assertion that the Nashville functioned as a truly separate corporation may have held more than a kernel of truth. Moreover, the amount of income received from the Nashville was a very small portion of the L & N’s total revenue and certainly not worth running a major subsidiary down physically to obtain. Such a practice would seem thoroughly inconsistent with the policies being pursued by the L & N board.
To be sure, the Nashville did deviate from the parent road in policy matters. It tried to gear operating and improvement expenditures more precisely to the gain or loss in gross earnings, spending more in good years and less in poor years. Though the road followed the L & N’s practice of paying for improvements out of earnings after 1896, it obviously did not devote most of its income to improvements. Clearly the Nashville sacrificed some of its upkeep, it is hard to say how much, to pay dividends. By 1899 it could no longer take that tack. The Depression was over, but improvements were badly needed, wages had risen, several new lines were acquired, and the floating debt drifted to $1,567,839. Reluctantly the board paid only a 1 per cent dividend in 1899 and then ceased all declarations for several years. Curiously, the Nashville stopped paying dividends just about when the L & N resumed them.
By January, 1899, the L & N had weathered the Depression years in good order. Unlike most other southern roads, the company never even approached insolvency or receivership and in fact emerged from the lean years in stronger condition than it had gone into them. The general confidence felt about the system and its management revealed itself in the market. After reaching a low of 37⅛ in August, 1896, L & N stock rallied steadily. It closed at 65¼ in December, 1898, and reached the high 80s during the next year. The issue of 5–20 collateral trust bonds in 1898 was oversubscribed, and earnings in 1899 seemed finally ready to exceed the previous high set in 1893.
These developments made the resumption of dividends natural and inevitable. In January, 1899, the board declared a 1.5 per cent semiannual payment. Six months later it repeated the action and even added a special declaration of ½ per cent. Even here Belmont proceeded cautiously. In 1898 he had noted in the Annual Report that “it is proposed to consider surplus hereafter earned over and above operating expenses and fixed charges for each year as a basis for dividends for such year, which dividends will be regulated by the amount so earned for that period, but it is not contemplated to use any of the accumulated surplus of the Company for the payment of dividends.”14 He deemed this a basic policy statement and was therefore quick to point out that the special dividend did not represent a departure from it:
The rate of 3 per cent per annum, which was begun at the last dividend period, cannot conservatively be changed, for the conditions governing the present satisfactory earnings of the road are not sufficiently settled to admit of raising the rate. Out of the surplus for the year, however, the board has concluded to pay ½ of 1 per cent extra, and to carry the balance over into the ensuing year.15
Conditions stabilized enough for the board to raise the rate to 4 per cent in 1900 and 5 per cent the following year. With the Depression past, dividends restored, the road in fine shape, and the management in strong hands, the L & N was ready to embark upon a new era and a fresh set of problems.
The onset of depression triggered strife between labor and management on several of the major roads, but the L & N escaped relatively unscathed. In fact the only major disturbance on the main system occurred early in 1893, before the Panic. Here, as with his administrative personnel, Smith took a hard line. His opinion of shirkers and “deadheads” embraced the field no less than the office. Especially did he despise unions, which he viewed as dangerous threats to the prerogatives of management and as refuges for rabble rousers and men unwilling to work for an honest day’s pay. From the rigid perspective of his laissez-faire credo, Smith reported to the board on the unions with unconcealed scorn:
As is well known to the … Board, most of our employees are organized into brotherhoods, or secret societies.… These organizations come at different periods and apply for increases in their compensation and for changes in the rules and regulations so as to give them less work and more pay. They have gotten so thoroughly organized that they come once a year, or have what they term their annual meetings … and then they come when anything transpires during the year that they think needs correction or regulation, and ask for adjustment of what they term their grievances.16
In January, 1893, several of the lodges journeyed to Louisville to present their “grievances.” After lengthy negotiations Smith granted some raises and changes in rules for the conductors and brakemen, but he rejected the demands of the engineers and firemen because they had received what he considered to be good raises two years earlier. To their protests he responded sharply that the company desperately needed money for improvements and could not afford wage hikes which, if given, would cost over $1,000,000 a year, force an end to dividends, injure the company’s credit, and render improvement expenditures impossible. As to further rule changes, Smith was adamant if not threatening: “No modification of the existing agreement tending to place the management of the company’s property under the control of any class of its employees or tending to destroy or relax discipline can be entertained. On the contrary, it is, I think, evident that some of the existing rules and regulations must be modified as to insure better discipline.”
When the firemen and engineers pressed their demands, Smith personally rebutted each item. At one point he declared, “In other words, if one of their men is to be tried, they want to have a man as one of the judges. That is what I term taking the management from the control of the company’s officers and placing it with the employees. We always resist that.” He took an equally hard line on every issue and absolutely refused any wage increase because of its effect on operating expenses. Finally the engineers withdrew and threatened to strike with support from the Brotherhood of Locomotive Engineers.
At once Smith ordered the general manager, as soon as the strike was declared, to “establish agencies in the principal railroad centers of the country east of the Rocky Mountains, for the employment of men to take the places of those who may refuse to work.” Believing that everything depended upon how effectively the strikers were replaced, Smith made thorough and careful preparations. He planned to move trains as quickly as replacements arrived and supplied the superintendents with priority lists showing what traffic should be moved first. He instructed the superintendents to avoid press publicity wherever possible and to make definite arrangements with local authorities to protect the company’s property. As an added precaution he also summoned a contingent of Pinkerton men as well.
Smith’s ruthlessly efficient organization scuttled any chance the engineers had for a successful strike. The board endorsed and sustained his position completely, and the crisis collapsed soon afterward. A month or so later, the board authorized the purchase of a new railroad car for its own use. That juxtaposition of events did not go unnoticed by some of the workingmen. Mindful of the experience and its legacy of bitterness, the L & N took pains to restore the wage cuts of 1893 before resuming dividends in 1899. Half the reductions were restored July 1, 1898, and the remainder on January 1, 1899. Nevertheless the L & N’s relationship with its workmen remained tenuous and often uncomfortable. Times were changing, and so were many aspects of management-labor relationships. These changes Smith observed with his usual keen eye, but they made little dent in his attitudes. Never one to back down from a fight, he was as willing to buck a trend as he was a rival road or an inquisitive state commission.