company was appraisals of its property at St. Louis, Caruthersville, and Springfield, respectively, as of December, 1913, February, 1914. and September, 1916, prepared by the commission's engineers and accountants, together with statements showing actual cost of additions subsequent to those dates. Omitting a paragraph relative to an unimportant reduction-$17,513.52 from working capital account, that part of the commission's report which deals with property values follows: "The company offered in evidence exhibits showing the value of its property in the entire state (outside the cities of Kansas City and Independence, whose rates are not involved in this case), and also at forty-six of its local exchanges in the state. It shows by such exhibits that the value of the property in the entire state (and when speaking of the property in the state in this report we mean exclusive of Kansas City and Independence) is as follows: Reproduction cost new, $35,100,471; reproduction cost new less depreciation, $31,355,278; and cost as per books $22,888,943. It also shows the company's estimate of reproduction cost new, less depreciation, and the prorated book cost, at each of the forty-six local exchanges mentioned. "The engineers of this commission have made a detailed inventory and appraisal, and this commission has formally valued the company's property at only three of its exchanges, viz.: at the city of Caruthersville, reported in Re Southwestern Teleg. & Teleph. Co. 2 Mo. P. S. C. 492; at the city of St. Louis in cases No. 234 and No. 235, as yet unreported; and at the city of Springfield, reported in Re Missouri & K. Teleph. Co. 6 Mo. P. S. C. 279; and, as a result, we have only the estimates and appraisals of the company before us in relation to the value of the property at the other exchanges. We think it is clear, however, from the data at hand, that the values placed by the company upon the property are excessive, and not a just basis for rate making. "The values fixed by this commission at Caruthersville, St. Louis, and Springfield, in the cases above mentioned, aggregate $11,003,898, while the company estimates the aggregate cost of reproduction new of these plants in this case at $18,971,011. The ratio of the latter figure is 172.4 per cent. This percentage, divided into $35,100,471, the company's estimate of the aggregate cost of the reproduction new of its property in Missouri in this case, equals $20,350,000, which might be said to be one measure of the value of the property. "Again, the company's estimate of the aggregate cost of reproduction new, less depreciation, of its properties at Caruthersville, St. Louis, and Springfield, in this case, is $16,913,673. The ratio of this figure to the aggregate value fixed by the commission at these exchanges, plus additions reported by the company, is 153.7 per cent. This percentage, divided into $31,355,278, the company's estimate of the aggregate cost of reproduction new, less depreciation, of its property in Missouri in this case, equals $20,400,000, which may be said to be another measure of the value of the property. "The company also shows by exhibits 19 and 212 that its return under the Postmaster General's rates on $22,888,942, the book value of its property in the state, is at the rate of 11.65 per cent per annum for depreciation and return on the investment, which would yield the company 6 per cent for depreciation and 5.65 per cent for return on the book cost of the property. As stated, however, we do not think that the book cost or the 'prorated book cost' of the property, as claimed by the company, would be a fair basis for rate making. "As we understand it, the 'prorated book cost' given in evidence by the company for the various exchanges is simply the percentage relation of reproduction cost new (262 U. S. 276, 67 L. ed. 981, 43 Sup. Ct. Rep. 544.) which the original cost of all property bears to reproduction cost new of all property, and, in individual instances, the actual cost might vary greatly, either up or down, from what an appraisal would show. If the company, to eliminate competition, paid a price in excess of the value, or, because of discouraged local operation, were enabled to purchase a plant far below its actual value, the 'prorated book cost' basis would not reflect anything like the original cost. "We also think that the figure of $22,888,943, claimed by the company to represent the book cost or original of the property cost in the state, is subject to certain adjustments with reference to the amount of nonuseful property included, working capital, and the amounts to be deducted account extinguished value recouped from patrons by charges to depreciation. "In the St. Louis case, supra, the original cost of the nonuseful property deducted and disallowed by the commission amounted to $454,689.16. It appears from the company's exhibit 256 that the 'prorated book cost' of the St. Louis exchange is just about half of that given for the state. However, it is clear that the proportion of the nonused and nonuseful property in St. Louis bears a much larger percentage relation to useful property than would obtain throughout the state. It would appear that estimating the company's property not used and useful for the entire estate at $500,000 would be a fair approximation. This sum, at least, should be deducted. "The depreciation reserve applicable to the Missouri property is not shown by the company. However, on the company's exhibit 15, the balance sheet as of June 30, 1919, of the Southwestern Bell Telephone Company (Missouri Corporation) operating in Missouri, Kansas, and Arkansas, the reserve for accrued depreciation and reserve for amortization of intangibles is given as $7,963,082.37. The same exhibit shows the original cost of fixed cap ital for Missouri, Kansas, and Arkansas property as $46,061,162.76. The total fixed capital of the Missouri property shown on the company's exhibit 19 is $21,837,759, which is 47.4 per cent of $46,061,162.76, and 47.4 per cent of the reserve for depreciation; $7,963,082.37 equals $3,774,501, or the portion assignable to the Missouri property. "Adjusting in accordance with the above, we have: Total plant and equipment, including working capital, as per company's exhibit No. 19, $22,888,943. Deduct property not used or useful, $500,000; deduct excess working capital, $17,513.52; deduct depreciation reserve, $3,774,501; [total to be deducted] $4,292,014.52; [net total] $18,596,928.48; add for intangibles, 10 per cent, $1,859,692.85; total adjusted original cost, $20,456,621.33. "After carefully considering all the evidence as to values before us in this case, we are of the opinion that the value of the company's property in the state, exclusive of Kansas City and Independence, devoted to exchange service, will not exceed the sum of $20,400,000, and we will tentatively adopt this sum as the value of the property for the purposes of this case. As stated, supra, this commission has formally valued only a part of this property, and we should not be understood as authoritatively fixing the value of the property at this time." The three earlier valuations to which the commission referred are: St. Louis, December, 1913, $8,500,000; Caruthersville, February, 1914, $25,000; Springfield, September, 1916, $815,000; total, $9,340,000. Between those dates and June 30, 1919, additions were made to these properties which cost, respectively, $1,623,765, $5,992, and $34,141. Adding these to the original valuations gives $11,003,898, the base sum used by the commission for the estimates now under consideration. Obviously, the commission undertook to value the property without according any weight to the greatly enhanced costs of material, labor, supplies, etc., over those prevailing in 1913, 1914, and 1916. As matter of common knowledge, these increases were large. Competent witnesses estimated them as 45 to 50 per centum. In Willcox v. Consolidated Gas Co. 212 U. S. 19, 41, 52, 53 L. ed. 382, 395, 399, 48 L.R.A. (N.S.) 1134, 29 Sup. Ct. Rep. 192, 15 Ann. Cas. 1034, this court said: "There must be a fair return upon the reasonable value of the property at the time it is being used for the public. . And we concur with the court below in holding that the value of the property is to be determined as of the time when the inquiry is made regarding the rates. If the property which legally enters into the consideration of the question of rates has increased in value since it was acquired, the company is entitled to the benefit of such increase." In Minnesota Rate Cases (Simpson v. Shepard) 230 U. S. 352, 454, 57 L. ed. 1511, 1563, 48 L.R.A. (N.S.) 1151, 33 Sup. Ct. Rep. 729, Ann. Cas. 1916A, 18, this was said: "The making of a just return for the use of the property involves the recognition of its fair value if it be more than its cost. The property is held in private ownership, and it is that property, and not the original cost of it, of which the owner may not be deprived without due process of law." See also Denver v. Denver Union Water Co. 246 U. S. 178, 191, 62 L. ed. 649, 661, P.U.R.1918C, 640, 38 Sup. Ct. Rep. 278; Newton v. Consolidated Gas Co. 258 U. S. 165, 66 L. ed. 538, 42 Sup. Ct. Rep. 264 (March 6, 1922); and Galveston Electric Co. v. Galveston, 258 U. S. 388, 66 L. ed. 678, 42 Sup. Ct. Rep. 351 (April 10, 1922). It is impossible to ascertain what will amount to a fair return upon properties devoted to public service without giving conPublic utilities- sideration to the tion of reproduc- cost of labor, supcurrent prices. plies, etc., at the time the investigation is made. An honest and intel rates-considera tion cost at ligent forecast of probable future values, made upon a view of all the relevant circumstances, is essential. If the highly important element of present costs is wholly disregarded, such a forecast becomes impossible. Estimates for to-morrow cannot ignore prices of to-day. Witnesses for the company asserted-and there was no substantial evidence to the contrary-that, excluding cost of establishing the business, the property was worth at least 25 per cent more than the commission's estimates, and we think the proof shows that, for the purposes of the present case, the valuation should be at least $25,000,000. After disallowing an actual expenditure of $174,048.60 for rentals and services by the American Telephone & Telegraph Company, and some other items not presently important, the commission estimated the annual net profits on operations available for depreciation and return as $2,828,617.60,-approximately 11 per cent of $25,000,000. That 6 per cent should be allowed for depreciation appears to be accepted by the commission. Deducting this would leave a possible 5} per cent return up- Telephoneson the minimum what is adequate value of the prop rate for service. erty, which is wholly inadequate, considering the character of the investment and interest rates then prevailing. The important item of expense disallowed by the commission$174,048.60-is 55 per cent of the 4 per cent of gross revenues paid by plaintiff in error to the American Telephone & Telegraph Company as rents for receivers, transmitters, induction coils, etc., and for licenses and services under the customary form of contract between the latter company and its subsidiaries. Four and one half per cent is the ordinary charge paid voluntarily by local companies of the general system. There is nothing to indicate bad faith. So far as appears, plaintiff in error's board of directors has exercised a proper discretion about this matter requiring business judg (262 U. S. 276, 67 L. ed. 981, 43 Sup. Ct. Rep. 544.) ment. It must never be forgotten that while the state may regulate, with a view to enforcing reasonable rates and charges, it is not the owner of the property of public utility companies, and is not clothed with the general power of management incident to ownership. The applicable general rule is well expressed in State Public Utilities Commission ex rel. Springfield v. Springfield Gas & E. Co. 291 Ill. 209, 234, P.U.R. 1920C, 640, 125 N. E. 891: "The commission is not the financial manager of the corporation, and it is not empowered to substitute its judgment for that of the directors of the corporation; nor can it ignore items charged by by disallow items the utility as operating expenses unless there is an abuse of discretion in that regard by the corporate officers." -rates-power to of expense. See Interstate Commerce Commission v. Chicago G. W. R. Co. 209 U. S. 108, 52 L. ed. 705, 28 Sup. Ct. Rep. 493; Chicago, M. & St. P. R. Co. v. Wisconsin, 238 U. S. 491, 59 L. ed. 1423, L.R.A.1916A, 1133, P.U.R. 1915D, 706, 35 Sup. Ct. Rep. 869; People ex rel. Delaware & H. Co. v. Stevens, 197 N. Y. 1, 90 N. E. 60. Reversed. Mr. Justice Brandeis, with whom Mr. Justice Holmes concurs: I concur in the judgment of reversal. But I do so on the ground that the order of the state commission prevents the utility from earning a fair return on the amount prudently invested in it. Thus, I differ fundamentally from my brethren concerning the rule to be applied in determining whether a prescribed rate is confiscatory. The 1 1 The term "prudent investment" is not used in a critical sense. There should not be excluded from the finding of the base, investments which, under ordinary circumstances, would be deemed reasonable. The term is applied for the purpose of excluding what might be found to be dishonest or obviously wasteful or imprudent expenditures. Every investment may be assumed to have been made in the exercise of reasonable judgment, unless the contrary is shown. court, adhering to the so-called rule of Smyth v. Ames, and further defining it, declares that what is termed "value" must be ascertained by giving weight, among other things, to estimates of what it would cost to reproduce the property at the time of the rate hearing. The so-called rule of Smyth v. Ames is, in my opinion, legally and economically unsound. The thing devoted by the investor to the public use is not specific property, tangible and intangible, but capital embarked in the enterprise. Upon the capital so invested the Federal Constitution guarantees to the utility the opportunity to earn a fair return. Thus, it sets the limit to the power of the state to regulate rates. The Constitution does not guarantee to the utility the opportunity to earn a return on the value of all items of property used by the utility, or of any of them. The several items of property constituting the utility, taken singly, and freed from the public use, may conceivably have an aggregate value greater than if the items are used in combination. The owner is at liberty, in the absence of controlling statutory provision, to withdraw his property from the public service; and, if he does so, may obtain for it exchange value. Compare Brooks-Scanlon Co. Railroad Commission, 251 U. S. 396, 64 L. ed. 323, P.U.R.1920C, 579, 40 Sup. Ct. Rep. 183; Erie R. Co. v. Public Utility Comrs. 254 U. S. 394, 411, 65 L. ed. 322, 334, P.U.R. 1921C, 143, 41 Sup. Ct. Rep. 169; V. 2 Except that rates may, in no event, be prohibitive, exorbitant, or unduly burdensome to the public. Covington & L. Turnp. Road Co. v. Sanford, 164 U. S. 578, 596, 41 L. ed. 560, 566, 17 Sup. Ct. Rep. 198; Smyth v. Ames, 169 U. S. 466, 544, 42 L. ed. 819, 848, 18 Sup. Ct. Rep. 418; San Diego Land & Town Co. v. National City, 174 U. S. 739, 757, 43 L. ed. 1154, 1161, 19 Sup. Ct. Rep. 804; Minnesota Rate Cases (Simpson v. Shepard) 230 U. S. 352, 454, 57 L. ed. 1511, 1563, 48 L.R.A. (N.S.) 1151, 33 Sup. Ct. Rep. 729, Ann. Cas. 1916A, 18; Mr. Justice Miller in Chicago, M. & St. P. R. Co. v. Minnesota, 134 U. S. 418, 459, 33 L. ed. 970, 982, 3 Inters. Com. Rep. 224, 10 Sup. Ct. Rep. 462, 702. r Texas v. Eastern Texas R. Co. 258 U. S. 204, 66 L. ed. 566, 42 Sup. Ct. Rep. 281. But so long as the specific items of property are employed by the utility, their exchange value is not of legal significance. The investor agrees, by embarking capital in a utility, that its charges to the public shall be reasonable. His company is the substitute for the state in the performance of the public service, thus becoming a public servant. The compensation which the Constitution guarantees an opportunity to earn is the reasonable cost of conducting the business. Cost includes not only operating expenses, but also capital charges. Capital charges cover the allowance, by way of interest, for the use of the capital, whatever the nature of the security issued therefor; the allowance for risk incurred; and enough more to attract capital. The reasonable rate to be prescribed by a commission may allow an efficiently managed utility much more. But a rate is constitutionally compensatory if it allows to the utility the opportunity to earn the cost of the service as thus defined. To decide whether a proposed rate is confiscatory, the tribunal must determine both what sum would be earned under it, and whether that sum would be a fair return. The decision involves ordinarily the making of four subsidiary ones: 1. What the gross earnings from operating the utility under the rate in controversy would be. (A prediction.) 2. What the operating expenses and charges, while so operating, would be. (A prediction.) 3. The rate base, that is, what the amount is on which a return should be earned. (Under Smyth v. Ames, an opinion, largely.) 4. What rate of return should be deemed fair. (An opinion, largely.) A decision that a rate is confiscatory (or compensatory) is thus the resultant of four subsidiary determinations. Each of the four involves forming a judgment, as dis tinguished from ascertaining facts. And as to each factor, there is usually room for difference in judgment. But the first two factors do not ordinarily present serious difficulties. The doubts and uncertainties incident to prophecy, which affect them, can, often, be resolved by a test period; and meanwhile protection may be afforded by giving a bond. Knoxville v. Knoxville Water Co. 212 U. S. 1, 18, 19, 53 L. ed. 371, 381, 382, 29 Sup. Ct. Rep. 148; St. Louis, I. M. & S. R. Co. v. McKnight, 244 U. S. 368, 61 L. ed. 1200, 37 Sup. Ct. Rep. 611. The doubts and uncertainties incident to the last two factors can be eliminated, or lessened, only by redefining the rate base, called value, and the measure of fairness in return, now applied under the rule of Smyth v. Ames. The experience of the twenty-five years since that case was decided has demonstrated that the rule there enunciated is delusive. In the attempt to apply it insuperable obstacles have been encountered. has failed to afford adequate protection either to capital or to the public. It leaves open the door to grave injustice. To give to capital embarked in public utilities the protection guaranteed by the Constitution, and to secure for the public reasonable rates, it is essential that the rate base be definite, stable, and readily ascertainable; and that the percentage to be earned on the rate base be measured by the cost, or charge, of the capital employed in the enterprise. It is consistent with the Federal Constitution for this court now to lay down a rule which will establish such a rate base and such a measure of the rate of return deemed fair. In my opinion, it should do so. It The rule of Smyth v. Ames sets the laborious and baffling task of finding the present value of the utility. It is impossible to find an exchange value for a utility, since utilities, unlike merchandise or land, are not commonly bought and sold in the market. Nor can the present value of the utility be determined |