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Electricity - Some Ethical Aspects of Replacement Reserves

( Originally Published Early 1900's )

THE NOTES from which I am talking have been written at long intervals during the past twelve months, and coordinated in a hurry during the last ten days. They are presented now, with the knowledge that they are incomplete and badly arranged, and with my apology for inconsistencies of terminology and inexactitudes of expression. I am not even attempting to write in the word "replacement" in place of the much maligned word "depreciation," in each phrase where the substitution would be acceptable. Every member of this audience knows the thing I actually mean, and he will call it replacement or depreciation, or some other name even less respectful, according to the way he feels about it just then.

Please understand that I am not discussing either the law or the accounting methods applicable to replacement reserves. I am talking ethics—a most elusive subject. My selection from among the definitions found in the dictionary is:

Ethics—the science or doctrine of the sources, principles, sanctions and ideals of human conduct and character.

I challenge the characterization of ethics as a science, and I am not willing to be limited to its definition as a doctrine; that is to say, a teaching. Anyhow, I am not teaching, nor preaching. I am making a few remarks about how some things look to me during the occasional hours when I can turn from the instant need of things to philosophize as to the causes and motives of things. I am making no inquiry into ultimate causes or original motives. I am content to leave these to whatever gods there be, and to guess at the ethics (if any) which may sanction certain overt acts.

Reasons for Existence of Reserves

It is more than twenty-seven years since I provoked a lot of protest from my friends in our industry by saying out loud in meeting that their acceptance of the fact of depreciation would justify our making specific provision for it out of earnings, and would, in my opinion, be a benefit to the industry. It is more than sixteen years since the Supreme Court of the United States said that the owners of a public utility property were not required to see their investment waste away without provision for its replacement or amortization.

(Mr. Dow here interpolated the following remarks which were included in the text as printed by the Association.)

Let me interject here a remark or two that are not in the print and perhaps will be blue-penciled out of the report. The year in which I said that making provision for depreciation, that recognition of its existence, would be for the good of the industry, was also the year of the decision in Smyth vs. Ames, which was the beginning of a long series of decisions by the court of last resort, declaring that the present value of the property devoted to the public service rather than its cost, was a controlling or (at least) very important factor in estimating its value for any purpose, and that to deny consideration of the present value would be confiscatory in the sense of the Constitution of the United States.

That decision in Smyth vs. Ames and the sequent decisions are the buttresses of all our present arguments in favor of rate basis and so forth being based upon present value. But at that time the decision raised the wrath of most of the leaders of the industry (although not all of them) and it was an exceedingly unpopular decision be-cause there was no question whatever that the then replacement cost of our property devoted to public service was very much less than its actual cost in money as originally installed.

Our industry has, by a majority at least, gone right about face. The Supreme Court, of which I must speak with due reverence (I am speaking, not writing, at the moment) has found itself in a rather awkward position, one which I think can well be illustrated by telling a tale of a young friend of mine; one of those darlings who at fourteen or fifteen years old charm our eyes today and promise, by their acceptance of soundness of body and soundness of mind, very great things for the tomorrow of the race. She turned up at an evening party with evident bruises about her arms and shoulders. Her hostess, asking how it happened was given the reply, "I took a tumble to myself. I was riding."

I don't want to suggest that the Supreme Court is going to take a tumble to itself, but you can please remember that saying as we go along.

The hostess, thinking to comfort and make happier the youngster, said, "You will never be a first-class rider until you take several tumbles to yourself."

Possibly that holds for courts as well as for young riders.

My young friend's response was precisely applicable to our cases and serves to complete a good parable. "Yes Ma'am, I don't mind taking the tumbles; but you see I was trying to ride Roman and I was getting along just fine until they split."

The Supreme Court has got to the place where the two horses insist on splitting, and I don't quite know what sort of a tumble the court is going to take. I have not the least doubt whatever that it will be graceful and will at least be camouflaged as consistent. Some way or other, however, we have got to get down to a little different status than we have now, where so many decisions re-quire reconciliations that (speaking in the parable again) would require the art of a rider of two horses in parallel.

(Mr. Dow here returned to the original text.)

But why a reserve? I ask the question so that I may point out an ethical reason—a somewhat overlooked ethical reason for its existence.

The dicta of final authorities during the last twenty years, and particularly during the last five years, have so well marshalled the major justifications for a replacement reserve that these are beyond challenge. It is now accepted that the setting up of periodic appropriations to a reserve account is desirable, or even imperative. The assigned reasons are that the invested capital may be protected from impairment; that advance provision may be made for replacements of a more extensive character then those which are incident to day-to-day maintenance; and that the accruals of impairment and the provision for replacement should be obtained from the public which is served during the life of the property with which the service is performed. An equally valid reason, less generally recognized, is that there shall be a reserve into which, during times of profitable business, larger payments shall be made, so that during the inevitable years of lean business lesser payments may be demanded.

This reasoning recognizes the use factor and the service factor as well as the time factor of accrual. The ethical considerations are that they who are served should be called on to pay for the service, and that their payments should be according to the value of the service to them. These considerations lie in the duty of our customers to us. Each is obvious and fundamental. The ethical reason usually overlooked lies in our duty to our investors. The warranted belief and expectation of the investor, whether his holdings be of senior or junior securities, are that when he has occasion to liquidate his investment there will be available a fair and free market. Thereby is laid on us the duty of seeing to it that the provision made (and continuing to be made) for inevitable replacements shall be so evident that its existence will not be questioned. Practically, that evidence must be the appearance in the balance sheet of the company of an accumulated reserve as a liability item, thereby showing that a suitable part of earnings of past years has been set aside to make good the necessity which has accrued during those years for making future expenditures for replacements. On the other side of the balance sheet there must needs be, of course, property or funds to counterbalance the liability item. It is not adequate evidence, convincing to careful investors, that there is an accumulated surplus. A surplus may at any time be diverted by the directors or stock-holders to purposes having nothing to do with future replacements. It may possibly be converted into cash and distributed to the stock-holders. A reserve may not be diverted to any other purpose than the protection of the integrity of the investment. It is true that a reserve is not in every case protected by law from diversion or even from division. I would not suggest that it should be so protected. I should merely hold the management to an accounting, on the merits of the case. The disappearance of a reserve account from the balance sheet demands explanation, and the explanation will need to be complete and clear.

I recognize that in some cases—for instance, in the case of a consolidation of properties—an accrued reserve will logically be diminished or capitalized, but the accounting record of that action puts all interested parties upon caution.

It is also true that accrued reserves much needed for their proper purpose, have been at times reprehensibly swept over into surplus and distributed; or have been made the excuse for a stock dividend. Again, I am most unwilling to limit the freedom of action of any board of directors. I would rather give them greater freedom and more responsibility. The point I am making is that a replacement reserve is ethically required in order that the free market to which the investor is entitled, shall be as free as it can only be made by the publication of full information of the condition of the company's property and of the provision made against accruing impairment of value; and that, conversely, the absence of such an account from the balance sheet is prima facie a warning to inquire as to what provision, if any, has been made.

To put the occasion somewhat crudely, I hold that the establishment and maintenance of a reserve account is ethically desirable be-cause, in addition to securing from the public the full payment which is collectable by the utility as a whole, it protects the free and open market to which security holders are entitled against harm by covert financial expedients which might be adopted for one cause (or excuse) or another by the management. Further, it has the ethical advantage of being evidence of good faith. It is fulfillment of the injunction to avoid every appearance of evil—not only to do no wrong but to avoid the semblance of wrongdoing.

If the individual ownership of all classes of our securities remain unchanged—if we were from year to year and generation to generation dealing with the same investors—certain ethical considerations would not come into our management problems. But although our conception of our service is that it is continuing and perpetual, we must remember that the personality of our stockholders and bond-holders is naturally in a status of flux, and that this natural flux must be unhampered if our financing is to be of the simplest and best character. A fair and free market for the disposal of individual holdings of any security—junior or senior—is implied; and the management, while its absolute duty is to maintain total values and not at all to control the market price for individual holdings, must see that the fairness and freeness of the open market is in no way limited by a failure to display significant facts.

As a director and as a manager I have more than once had my peace of mind established, and my ability to serve assisted, by the knowledge that replacement reserves had been provided rather than additions to surplus. Possibly the provision of peace of mind for the management is an ethical desirability. Possibly my desire for such a provision is just an indication of laziness.

Ownership of Reserves

There never was any ethical question as to the ownership of our reserves. They belong to the company, whether reinvested in the property, or in temporary investment pending application to their designed use, or lying in bank as cash. Any honest expression of contrary opinion has been the result of incorrect reasoning. Neither has there been any ethical doubt as to the management being a trustee for the proper use of reserves.

These ethical considerations have recently been reduced to equitable rulings, and there will presently be an end of confusion which has resulted from the false assumption that the existence of a reserve was an acknowledgment of the existent depreciation, rather than an anticipation of its inevitable accrual. There will be an end likewise of the many false assumptions resulting from mental confusion between the recorded cost of a property and its proven present value.

It follows that the public will be best served by letting the reserves be controlled by a competent and honest management representing the ownership of the reserves, and holding that management to a proper accounting. Nevertheless, some public supervision of the use of reserves is justified by the same ethical considerations as any other public supervision, namely, the good understanding which must needs be obtained between fellow mortals when there are no concealments of act or intent. I am nowhere assuming that all public supervision is good. It is not good if it is meddlesome, and there has been detrimental meddling in the effort of some commissions to regulate the applications and uses of reserves. To recite a list of foolishness would be unprofitable and would be alien to my text.

An Example of Regulation

Here is a workable regulation, however, which invites study. It is in some states ordered that unexpended replacement reserves shall be credited with interest at a specified annual rate which credit shall be a charge deductible from the total annual return permitted by the commission to be earned by the company. Assume by way of example that an annual return of 8 per cent upon the present net valuation of the property has been allowed. This valuation will include all the property in evidence whether it has been paid for out of capital or out of surplus or out of depreciation reserves reinvested in betterments. This expression reinvested in betterments must, of course, be distinguished from the expression expended for replacements.

At first glance such a regulation looks like an interference with the property rights of the company. On study it appears that the company has a certain balance not needed to make immediate replacements which in its discretion it may either (a) carry as cash, (b) invest in interest-bearing securities or (c) reinvest in the property. Ethically the balance on hand is part of the useful property of a company whose primary purpose is to serve the public, and singleness of mind will require the management of the company to devote it to that purpose. Its instantaneous devotion might be inconvenient or excessive. But it is not in the interest of the public nor of the company that the money shall lie idle. The alternative of putting it into interest-bearing securities readily marketable when the money is needed would be acceptable providing that the interest with which the reserve is required to be credited shall not be at a higher rate than that which could be earned by these outside securities. In practice, however, the mandatory interest is at a higher rate. If, as already assumed, the return allowed on the valuation is 8 per cent, the mandatory annual credit to the unexpended balance may be 6 per cent, while quick marketable securities—securities acceptable in a trusteeship—may not earn 5 per cent.

There is, therefore, a pressure put upon the company, either-to anticipate replacements when reserves become inconveniently large, and thereby serve the public with newer and more efficient apparatus, or to put the 6 per cent money into betterments and extensions of the general service. In the one case, the money having been expended in replacements is not thereafter required to be credited with interim interest. In the other case the 6 per cent money has been put into an 8 per cent service of the public. In either case the company and the public are alike well served, which is the ethical requirement. And there is an end of the temptation to divert the accumulation to inferior uses.

Diversion of Reserve Funds

The last sentence invites an examination into another practice which may exist. I, being merely philosophizing, am not required to prove its existence or give it a local habitation. Consider the case of a holding company, some of whose properties have been able to accumulate creditable reserves. Let us assume that there are a dozen properties in scattered localities, all in the same control; some of them having reserve funds not immediately needed, others urgently in need of money, and the rest of them betwixt and between. Is any pooling of reserve funds permissible? If so, is it ethical for the holding company to issue its notes, debentures or other obligations in exchange for cash of the one property, and thereafter lend this money to another property at a higher rate of interest? If I should raise this issue as to any concrete case I should be met with the scriptural saying, "Shall I not do what I will with mine own?" Quite true; providing that one's own is not held in effect as a trust. Is there no duty to minimize the amount necessary to be collected towards a replacement fund from the consumers who are served by each separate company? An accepted device for minimizing that amount is to invest any temporary excess of collections at the largest profit consistent with safety—providing, of course, that the excess cannot be turned back forthwith into the service of the same group of consumers which has paid in the money in anticipation of its own proper calls for future replacements. I think we can let these academic questions pass on with the remark that if such practices now exist or ever did exist they are or were unethical.

(Mr. Dow here interpolated the following remarks which were included in the text as printed by the Association.)

At the time I wrote the foregoing, I had not received the record in the case of Slaymaker vs. Columbus Railway Power and Light, in which comparable questions are raised. In that case certain minority stockholders, under the laws of Ohio, brought suit against the corporation, against the directors, against the holding company which had a management contract, and against sundry other people for an accounting and refund on the ground that the relation of the holding company, the management company, was in effect a trusteeship, that it was a fiducial relation. I believe the case has gone through three courts, and its last possibility of reversal is in the Supreme Court of the United States; and there is some question as to how it can be got there. Each of the courts has held that the question whether the relation in any such case is or is not that of trusteeship is a matter of fact, not a matter of contract. One of the courts, in fact, held flatly that the contract between the company and the management company was void from the beginning, but that, nevertheless, the holding company did have charge, was in complete control, and was bound to do equity because it was in control. In brief, the holding company in this decision is burdened with the status of a trustee, and is required, in this instance, to give a very full accounting and a refund to minority stockholders.

Let me call your attention to the fact that a trustee is pretty much the only person who comes before a court in the United States in the position of being guilty unless found innocent. That is a strong way to put it, but it amounts to this: Any other person coming before the court is presumed innocent of any wrong act unless he is charged with the wrong act and duly found guilty, whereas a trustee being in the position of having those who trust, whose interests are committed to his care, absolutely in his hands, must come into court saying, "Behold, this is what I have done" and is required to make professions such as you will find in the old Egyptian Book of the Dead, where the soul under judgment says "I have not done this, I have not done the other evil, I have done no wrong; I have not robbed the poor; I have accounted for everything that was committed to my care that belonged to those dependent upon me."

That particular Ohio decision puts the managing company in the position of trustee merely for the minority stockholders in this particular case, but with dicta which do not require much extension to imply that the holding company in all matters that may come before a court shall be subject to the same rules of evidence as the trustee; namely, that he must show affirmatively as regards the property which has been in his hands that he has done justly and equitably. In this particular case, the holding company's commission or fee of 1 1/2 per cent was set aside, and directed to be repaid excepting such amounts (a small portion thereof) as had actually been paid out for salaries or expenses. A profit made on the handling of a bond issue by the holding company as underwriters was set aside and required to be returned. A fee paid for the supervision of the construction of a plant, was challenged but was allowed as reasonable. Other items of actual expenditures were charged back, as not permissible by a trustee.

It can be put very clearly (this is verbal, subject to editing with permission of the Association) that the position of the holding company today is getting to require a very exact definition and very exact observance of not merely the law but the ethics; and that those holding companies who have wisely restricted their dealings with their subsidiaries or controlled properties, first, to the receiving of a reasonable or liberal return for money invested and secondly, to the repayment to them of expenses incurred, or payment to them for specified service actually rendered and billed, are going to be in the happy position of not being subject to challenge; while those others whose relations are covered by a bunched amount of so much percentage of gross earnings, or other figures of that kind, are going to be required to go into details and give a trustee's accounting.

That is perhaps prophecy and it may be prophecy of evil, be-cause any surge of public opinion or of court precedents in such a direction is bound to have some of the characteristics of a tidal wave and do damage as it goes along. That such a movement is in its initial stage now is beyond doubt, in at least one state, and I think others are threatening to change the rule of evidence in such manner that any controlling company collecting a management fee may be required to show what it does in return for the amount received.

(Mr. Dow here returned to the original text)

Upper and Lower Limits of Reserves

It would seem that discussion of a proper upper limit of a re-placement reserve in any of our companies is not only academic, but futile. The calls for replacements which are needed merely to maintain service are so numerous, and in these latter years so costly, that our temptation has been to continue the operation of inefficient machinery and to patch up old buildings and lines. We have seldom been tempted by excessive reserve funds to anticipate the date when one or another replacement would be unavoidable. Yet there have been instances in our own industry where the growth of replacement reserves has invited consideration of a possible ethical upper limit thereto. It is conceivable also that under certain familiar circumstances reserves may accumulate to an amount in excess of the evident requirements. For instance, the reserve appropriations contemplated by the drafts of certain Federal power leases might pile up unused and unusable, while the plant continued to function perfectly and could not be replaced by any better plant, and while circumstances nevertheless debarred the amortization of any part of the investment. Or, in our neighboring telephone industry the funds intended to provide for the entire and (literally) instantaneous substitution of new exchange equipment for old, may, because of changes in the art or because of controlling local conditions, be found to be un expendible at the expected time. Such instances are so evidently peculiar as to require action which is applicable only to the particular instance and forms no precedent for other cases.

The problem which it is profitable to consider is that which will arise when a well established plant, so well maintained that a critical appraiser will estimate its condition at 90 per cent, or better, finds that its reserve is exceeding, say, 10 per cent of the plant value. In such a case, what is ethically required of the management?

It is no longer debatable that the accrued depreciation of a plant cannot be measured by any fixed rule, but must be estimated by competent persons familiar with the facts and proven by the testimony of accepted experts. Neither is it debatable that differences will appear in the estimates of equally competent individuals; and that if two or more of these be required to agree on a report, their unanimity must needs be arrived at by compromise. All recent decisions of the highest courts are consonant in this respect. The preferable form of an expression of judgment as to the present condition of a property will, therefore, be that it is not worse than a certain percentage of new condition and not better than a certain - higher percentage. Having in mind our convenient assumption of approximately 90 per cent, the expression might well be that the condition was not worse than 87 per cent and not better than 93 per cent. This variation of, say, 3 per cent plus or minus must be borne in mind, in considering the question now before us.

The public which we serve is a creature of habit. Being for the moment content, it does not like to have its contentment disturbed. Ethically, it is better that our public should be well pleased than well served, because (after all) it is happiness which is pursued by the individual, and to make him unhappy or uncomfortable or to trouble him with much palaver merely that exact justice shall be done, is conduct which merits no thanks and may deserve reprobation. A meticulously exact adjustment of a running account is seldom worth the trouble by which it is obtained. It certainly is not worth while to upset the operation of a satisfactory rate schedule and to make the many adjustments which will be required thereby, just to prevent the collection for one year, or for two or three years, of a small percentage of earnings in excess of theoretical requirements. Therefore, so long as the accumulated reserve is within the limits of error of observation as to total requirements, it is unnecessary and absurd to disturb its equable accrual. Only when the reserve is very evidently inadequate, or very evidently excessive, is it ethically desirable that there should be altered the orderly process to which our public is habituated.

There is no concurrence in the dicta of the commissions and the courts as to how frequently public utility rates should be readjusted. The ready response of the commissions to public opinion and the unwillingness of any business management to disturb its routine by an increase of price, serve alike to make it easy and quick for rates to be changed downwards and difficult and slow for them to be changed upwards. The extensive advertising, notifications and hearings which are required in some states before any increase can be made in an electric rate, may be in their inception nothing but indications of the desire of governmental officers to please the voting public; but, in effect, these requirements tend to stabilize existing schedules and prevent their response to minor variations of costs or profits. Also, the dicta of some wise commissions that they wish rates to stay unchanged for measurably long periods and that when the changes are made they desire that these shall serve to adjust proven past misadjustments and not be solely anticipatory of expected changes, are recognition of the value of stability of costs to the business man as well as the unwillingness of the ultimate consumer to be called to reconsider his personal budget.

It thus appears that the upper limit of a replacement reserve cannot be strictly defined, and that action towards delimitation of the upward progress of the reserve is not required until there is ample evidence that the accumulation is excessive.

Another important consideration is as to whether the appropriations to the reserve have been reapplied to the service which earned them, or have been set aside as a fund, in cash or in securities quickly convertible into cash. I am not considering the case which seldom arises where it is permissible to use these appropriations to retire temporarily part of the funded debt, by calling in bonds which later can be resold. Neither am I considering the case where the appropriations have been definitely assigned to amortize capital. In the common case where the accumulations of the reserve have been devoted to increase the property usefully applied to the service of the public, without increasing the burden of capital charges to be paid by the public, it would seem as if the ethical obligation to the public continued to be fulfilled even though the accumulated reserve should be somewhat excessive. The ownership of the property acquired by the reinvestment of the reserve is vested in the company, but the enjoyment of the fruit of that ownership is waived in favor of the public. The public is thereby well served.

Contrariwise, if the accumulation is in cash, or in the equivalent of cash, then the public is not well served. Idle money serves nobody. Money invested in government or municipal bonds may be serving everybody, but in this case it is money diverted from its purpose. A temporary diversion into so-called savings bank securities may be permissible and commendable. Our duty is to serve according to our own fashion. As an incident of that duty we must have cash working capital, and we should have some sort of a casualty or contingent fund, in liquid form, set aside against the proverbial rainy day. Any accumulation of cash or of liquid assets beyond evident needs is beyond our duty, if not ultra vires and should have the most complete and explicit justification.

It thus appears that when accumulated replacement reserves are reinvested in the service of the same public which has provided these reserves, there is little ethical reason for defining the upper limit of accumulation. Whereas, when the accumulations are locked up as idle cash, or are put to inferior uses, continuance of the accumulations should be permitted only when it is amply excused by provable conditions.

Noting once more that the setting of any upper limit can be made only by the acceptance of some expert opinion, I offer my own opinion as that of an expert qualified to discuss the needs of the more common type of electric light and power property; namely, that which serves a territory principally urban, together with a reasonable amount of rural territory; which generates its current by steam; whose mains are underground in congested areas and over-head elsewhere, and whose business is growing at about the average rate, so that a fairly large proportion of its equipment will always be of recent date and, therefore, in 100 per cent condition. The assumption is, of course, that current maintenance is such as to give substantially 100 per cent operating efficiency. This assumption is vital, both for the argument and for good service. The net accrual of reserves must, therefore, be sufficient to provide for all replacements which are not being taken care of by ordinary maintenance and need not be in excess thereof.

Limits by Expediency

Now, some forty years' knowledge of operation, maintenance, management and valuation of such properties has taught me that a property which is in 100 per cent operating efficiency is likely to be as a whole in 85 per cent condition or better, as referred to replacement cost. This is a very broad generalization and it will not hold for the cases where a large part of the investment is in one class of property; for instance, where much the largest item is a costly water power plant; or where a disproportionate amount of expense has been incurred in placing the entire distribution system under-ground; or where a general and rapid increase in land values has tremendously raised the value of real estate. My statement may lack a theoretical basis. But it is nevertheless accurate or nearly accurate in the great majority of cases, and my philosophy is that of the business man—pragmatic rather than fundamental.

My reasoning is that 15 per cent of the plant value, expressly including real estate, is a good upper limit for a replacement re-serve; thus—if the plant as a whole is in less than 85 per cent condition I should expect to find that current maintenance has been neglected. If I found that the neglect was intentional and because of expected early complete replacement, such a finding would be warrant for a larger reserve. If I found that the maintenance was inadequate through neglect, I should, of course, hold the management at fault. If I found that the maintenance was up to the mark, then I should give serious consideration to reducing current appropriations for replacement reserve.

Now to consider a reasonable lower limit. Once again the question of concensus of expert opinion comes into the problem, and the probably mean difference between opinions may well be 3 per cent plus or minus. This gives a 3 per cent depreciation reserve as an irreducible minimum, and makes defensible any greater figure which would correspond to the mean value of several competent estimates of condition as a whole.

The practical question, however, is what is ethically required of the management and what is due to the management by the public towards the accumulation of a minimum reserve. Once more I offer an expression of opinion based on long experience, as follows: In a mixed property, fairly representative of the majority of electric light and power properties, the expenditures for imperative replacements tend to average about 2 per cent per annum of the whole fixed capital, including real estate. This implies a term of years long enough to make a fair average and is not applicable to a brand new property, neither to a neglected property.

It is also my observation of our industry that a period of depression seldom lasts with us for more than three years. Ours is usually the last business to feel the effects of a general depression and the first to show recovery. These are characteristics of youth, both as to human beings and as to industries. The resiliency of the twenty-year-old, the quick recovery from fatigue or from injury, are not characteristics of the man or woman who is past middle age. I do not think that our industry has reached middle age. Looking forward with what little gift of prophecy has been granted to me, I think that its middle age is far away. It is in its youth and its ability to recover is that of youth. I think we can say that there are not likely to be three successive years in which any representative property in our industry will not be able to make its necessary replacements of each year out of that year's earnings.

It follows that a reserve fund equal to 2 per cent for each of three years—that is to say, 6 per cent in all—the percentage being that of the whole value, will be sufficient to prevent an actual impairment of capital, as by incurring debt to make a replacement. Of course, an impairment of capital is not the only evil to be avoided. A cessation of dividends, by disqualifying our securities as investments, will seriously hurt our ability to finance future needs and thereby cripple our service to our public. The ability to continue dividends should, of course, be provided for by the accumulation of a reasonable surplus, which is ethically another thing from the accumulation of a replacement reserve, and should in no case be confused therewith.

It would seem that any set figures for maximum and minimum reserves would be subject to plus or minus error of the order of 3 per cent; and that, therefore, no hard and fast figures should be set up either by the management or by any supervisory authority. It would seem that where the reserve accumulation is reinvested in the active business of the company—the investment being re-corded as that of a reserve and not confused with the reinvestment of surplus—that the public is well served thereby, and that there is no ethical objection to a large reserve. Conversely, when the reserve is in fact set aside in cash or savings bank securities, the public is thereby only served in a collateral or inferior manner, and the necessity for the accumulation of a reserve in that form should be a matter of proof. And I have suggested, from purely practical considerations and for a representative plant, 6 per cent as a lower limit, or danger line, and 15 per cent as an acceptable upper limit.

Reserves—Compulsory or Optional

Should the keeping of a replacement reserve account be compulsory? If so, should the making of arbitrary appropriations from earnings to that account be made compulsory, as has recently been advocated before the Interstate Commerce Commission? I can see no ethical consideration calling for a rule as to the amounts, or periods, of appropriations. All parties affected—investors, managers and employes, and the public which is served—will be better served if appropriations are made at the discretion of the management, guided by the conditions existing at the time, or reasonably foreseen.

The argument for annual appropriations proceeds on the assumption that each year's business is a person having ethical duties or ethical inhibitions, and that this fictitious person should do his full duty to the next year and the year after and all other years of Our Lord, by closing up his accounts and paying his debts during his life time. The contention becomes absurd when it is remembered that our relations with the actual people whom we serve, although not perpetual with any one person, yet have with each person (subject to accidental exceptions) such a continuity as to cover one business cycle of prosperity and reaction, and indeed several such cycles.

The ultimate expression of ethics is that we shall so conduct ourselves as not to reduce the sum-total of human happiness, and shall endeavor to add thereto. There is no requirement that we shall strike a balance of our account with that sum-total, either annually or monthly or every minute. There must needs be a time and times between judgment days. And we know that each of our fellow mortals is much happier in giving, or in paying his debts, even in being fleeced a little, when he has the wherewithal than when he has nothing left to him but his skin.

As to there being any ethical requirement for a mandatory reserve account—I have my doubts. I think that problem must be referred to expediency rather than to ethics. Let us acknowledge that a highly competent and absolutely honest management might be left to keep its accounts in any way that it pleased, and that the observance by that management of the last fraction of the rights of those who confided in it, would be most perfect if there were neither supervision nor accounting. Nevertheless it is not an invasion of human rights that a laudable custom is formulated into a law. The harm comes when the formulation or the interpretation thereof is too legalistic—when the letter which killeth is preferred to the spirit which giveth life.

Of the making of laws there is no end. I am ready to work and vote for a level headed politician who knows his job and who will run on the platform that we have already too many laws and pledge himself to repeal a law every day. My willingness is predicated on the belief that his best efforts will not be crowned by the elimination of all law and the appeal of our mundane problems to ethics. Because then we should have to codify ethics into law—and so on forever. Which brings me back to the point from which I started, and to my stopping place.

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