The Theory of Prudent Investment

December 22, 1937

Report Outline
Coming Supreme Court Decision of Valuation
Reproduction Cost Theory and the Courts
Prudent Investment Theory of Valuation
Roosevelt's Attitude on Utility Valuation

Coming Supreme Court Decision of Valuation

The impending decision of the Supreme Court in a California case involving regulation of gas rates may have an important bearing on one phase of the conflict that has divided the Roosevelt administration and the public-utility industry. The case at bar affords the Court an opportunity either to affirm its long adherence to the doctrine that reproduction cost must be given consideration as a factor in valuation of utilities for rate-making purposes, or to relax that rule so as to give wider scope than heretofore for application of the prudent-investment theory of valuation advocated by President Roosevelt and by many economists.

A decision permitting regulatory commissions to ignore reproduction cost would simplify the process of rate-making and might be expected to work to the ultimate advantage of consumers. At the same time, it should influence the utilities generally to follow the lead of Wendell L. Willkie, president of the Commonwealth and Southern Corporation, who in a memorandum submitted to the President last month included adoption of the prudent-investment theory among proposals designed to establish more cordial relations between the public-utility industry and the federal government. The President's conferences with Willkie and with other utility executives have formed part of the administration's current efforts to find means of stimulating construction as an aid to recovery from the present business recession. It has been stated that expenditures by the utilities amounting to possibly $1,500,000,000 might be undertaken within the next year if the companies and their investors were confident of a more friendly attitude on the part of the government.

Support of Brandeis Views on Prudent Investment

After a conference on December 21 with F. R. Phillips, president of the Duquesne Light Company of Pittsburgh, and W. H. Taylor, president of the Philadelphia Electric Company, President Roosevelt disclosed that the discussion had centered on the prudent-investment theory as set forth by Justice Brandeis in a dissenting opinion, in 1923, in the ease of Southwestern Bell Telephone Co. v. Public Service Commission of Missouri. Particular attention had been devoted, the President said, to that part of the Brandeis opinion which stated that the basis for rate making should be the actual money invested, less items found to have been dishonestly or imprudently expended. Roosevelt, added that in the latter category should be included such items as graft paid to obtain franchises and excess amounts paid for properties bought at figures above their real worth. He asserted that, conversely, high valuations should not be allowed in the case of properties bought at low figures and left undeveloped until an opportunity arrived to write up the capital figure.

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