Railroads were the form of transport that revolutionized American business. As one of the first big businesses in the United States, railroads had a positive effect on accounting, auditing, finance, management, and marketing practices. They also enabled other businesses to expand throughout the country.
What made railroads modern businesses was the capital requirements of these enterprises, which were far in excess of those of other contemporary businesses. This meant that external financing had to be sought to construct a railroad line. Although other businesses were owner-operated ventures that required no more than local bank loans, railroads required more funds than one person could risk because of the capital needed to construct a line. This created new issues of how to communicate with external investors regarding the performance of the railroad and how to monitor the railroad managers who were stewards of the company’s assets. These so-called agency, or
Initially, there was a quasi-public nature about railroads. Governments played key roles in helping establish early rail lines. Besides providing support through the purchase and guarantee of securities, many state and local governments assisted individual railroads through land grants. Also, because railroads were often natural monopolies sanctioned by the state, their securities were viewed as akin to those of governments. In many cases, investors were not so much investing in the leadership of the railroad company but in the manufacturers, farmers, and consumers of the area in which the railroad operated. Thus, railroad securities were in some ways akin to government securities.
The B&O was formed in 1827 as merchants of Baltimore sought to preserve their city’s commercial advantage as a seaport linked with the American interior. The city had risen to third in size in the United States because of the construction of the
A B&O 5600 locomotive at the World’s Fair in New York in 1939.
Because Baltimore did not have direct river access to the west, merchants of the city were willing to consider all ideas. Banker Philip E. Thomas had been corresponding with his brother, Evan, who was in England and was excited about “railed roads” there. Similarly George Brown, an investment banker, had been hearing from his brother, William, in Liverpool, about British railroads. So Thomas and Brown met over dinner and discussed the possibility of a railed road connecting Baltimore with the Ohio River. The two believed that the cost of construction of the railed road, even though it had to pass over mountains, would be less than the cost of the Chesapeake and Ohio Canal (the nearest competitive alternative), and the two felt that the railed road offered mechanical advantages, including that horse-drawn wagons could be pulled efficiently in a train on the smooth rails.
Merchants of Baltimore met and seized on the railed road idea. Investors quickly subscribed to thirty thousand shares of $100 stock, as virtually every citizen of Baltimore supported the enterprise. City of Baltimore and state of Maryland funds also were invested, as these entities received half ownership of the shares, making the B&O both a public and private entity. The incorporation act specified that the Maryland legislature would set freight and passenger rates and that the B&O would not pay taxes. An annual report issued by the corporation to its shareholders was required by the B&O corporate charter; however, the contents of the annual report were not specified.
The size and growth of the enterprise from the time of the initial public offering were significant. The railroad management quickly evolved into a separate professional class with only a small ownership interest but with expertise to run the operations. This early evolution would lead to agency relationships, which were significant in the development of accounting, auditing, finance, and business management. In accounting, the corporate annual report would evolve, becoming an essential financial communication device for management, describing the company’s performance and its role as the steward of shareholder assets. These financial statements developed into the basic income statement, balance sheet, and early cash-flow report.
As they grew, the early railroads encountered new control problems involving how to deal with large volumes of business transactions occurring daily across long distances and with a multitude of employees handling cash or originating otherwise complex transactions. These employees ranged from ticket agents and freight agents at each station and depot to conductors on each train. Cash disbursements were the responsibilities of an ever-greater number of employees. Control over cash transactions would push accounting from the family-owned businesses’ journal-ledger system of recording infrequent transactions to the development of techniques to ensure proper recording, transferring, safeguarding, depositing, and handling of cash. The railroads handled control problems by developing internal auditing and training accountants in legion. The accounting profession would become firmly established during the manufacturing revolution of the late nineteenth century.
Financial innovations were sparked by the railroads. The railroads raised large amounts of capital, requiring wider public sale of stock and bonds. This expanded the role of investment banking and the securities houses, which had previously been trading mostly government debt obligations. Railroad securities laid the foundation for industrial firms to issue stocks and bonds to the public half a century later. Innovations in the types of bonds issued were also a product of the railroads–as “mortgage” bonds, “interest” bonds, debentures, and a wide variety of other types of debt obligations evolved. Railroads also changed the practice of businesses’ paying out profits as dividends to owners. Retention of profits became a major source of financing for the nineteenth century railroads. The early use of preferred stock can also be found at the B&O Railroad.
Railroads created a new standard of precision of operations. To be successful, the railroad had to operate trains in a safe, efficient manner, which required a close coordination not widely practiced at the time. Operating from distant locations and running trains traveling at different speeds on one-way track in both directions required all employees to work by the same strict standards, from the establishment of a standard (“railroad”) time system, to maintenance of the equipment and lines, and to strict adherence to procedure. Supervision was needed, and lines of authority were drawn. A hierarchy became established. Managers with special expertise evolved into a professional class who organized activities and made resource allocations. Railroad success depended on throughput: running the trains full and fast, and turning them around quickly. This concept was revolutionary in its day but became the essence of the Industrial Revolution, as high-volume plant utilization of fixed-cost facilities drove down cost per unit. Managing by accounting for costs of a department and other subunits and by statistical factors, such as cost per freight-ton-mile, evolved with the railroads.
The railroads revolutionized the economy: Freight costs declined dramatically, and travel time between cities or regions of the country decreased from days to hours. The interior of the United States became open to farming as farmers’ produce could be shipped to market and to merchants who in turn could sell goods to rural customers. The railroad saw the development of support industries and professions, including civil engineering, the coal industry, the steel industry, and the travel and vacation industry. Telegraph lines were first placed on the railroad rights of way, and the telegraph quickly became an essential way of communicating and coordinating train traffic.
The B&O published excellent
The Illinois Central, sometimes called the Main Line of Mid-America, was the country’s first cross-country railroad system, extending from Lake Michigan in the north to the Gulf of Mexico in the south. It also was the country’s first land-grant railroad and thus an experiment in social economy. The transportation provided by the line was the intended product of a collaboration by northern senator Stephen Douglas of Illinois and southern senators Jefferson Davis of Mississippi and William R. King of Alabama, who joined forces to provide an unprecedented form of federal subsidy that could link agricultural markets and shipping points in the emerging population centers in the Midwest and South. The subsidy, in the form of federal land grants, was to shape the modernization of the American frontier. The country’s rich interior land was almost worthless without access to markets, which railroads were to provide.
The land-grant legislation of September, 1850, marked the first time that
The incorporators’ plan for financing the Illinois Central was simple and, to insiders, most attractive. They anticipated using the land grant as security for a bond issue, the proceeds of which would pay for construction. Thereafter, the bonds could be paid off with proceeds from the sale of the lands, whose value was enhanced by the transport provided by the railroad. This would permit the incorporators to own the railroad and to operate it with minimal investment. In March, 1851, the Illinois Central board of directors held its first meeting and authorized a deposit of $200,000 with the state to guarantee good faith on behalf of the incorporators. The deposit came from the sale of stock to the thirteen incorporators. The incorporators wanted to keep their cash investments at a minimum. Bond sales were slow, particularly in Europe, where investors, especially in England, were wary of the state of Illinois because the state had missed interest payments on several loan agreements. However, by adding options to buy stock, large quantities of bonds were eventually (mid-1852) sold in both the United States and in Europe.
Many frauds involving railroads occurred during the early years. In 1856, as the Mobile and Ohio Railroad was being built north, management problems occurred because the president and another officer speculated on acquiring land along the route. This conflict of interest between the officers and the railroad resulted in considerable controversy and the firing of officers involved in the land speculation. Noteworthy is the fact that an audit committee was designated by the board of directors to investigate the president. Fortunately, the M&O had a set of bylaws that mentioned ethical issues–a rare phenomenon at the time. Other small frauds took place at other railroads, but the king of railroad frauds involved the financing of the transcontinental railroad.
The investigation disclosed that Colfax had received twenty shares of stock in Crédit Mobilier and dividends of $1,200 from that investment. Colfax asserted that he had never owned any stock that he had not purchased. Similarly, he claimed never to have received the supposed $1,200 in dividends. However, the House Judiciary Committee investigation determined that Colfax had indeed deposited $1,200 into his bank account just two days after the supposed dividend payment. After two weeks, Colfax explained that the deposit had been a campaign contribution from a friend who had since died. Even his strongest supporters doubted this story.
The history of railroad regulation is a combination of social, cultural, and political phenomena, which together are justified by increased efficiency and lower prices for consumers. The early history of railroad regulation was state based, but in 1887, the federal government took over with the establishment of the
In 1968, the Pennsylvania Railroad and the New York Central Railroad merged to form the Penn Central Transportation Company (PC). Two years later, the PC, then the largest railroad in the United States, entered reorganization under the Bankruptcy Act. The bankruptcy led to the 1976 creation of Conrail. The PC’s failure is illustrative of the problems of the railroad industry during the late 1960’s. The PC was a victim of undesirable industry trends; the railroad industry was a sick industry. A big problem was that railroads were heavily regulated by the ICC and were still treated as if they had the transportation monopoly they had during the late nineteenth century. The railroad industry’s freight market share decreased from 67 percent in 1947 to 40 percent in 1971, and government money was spent building highways and airports, while the railroads had to provide maintenance on their own track structure. Meanwhile, although the U.S. Postal Service diverted mail shipments from rail to both air and road, the ICC forced the railroads to continue operating money-losing passenger trains until the 1971 creation of Amtrak.
Basically, the railroad industry was impeded in its ability to compete by excessive regulation. Additional railroad bankruptcies in the Northeast led to the creation of a government-owned Conrail in 1976, and the government’s response was to phase in deregulation of the industry. The bankruptcy of the PC was final proof that railroad regulation was not needed. The regulatory system for the transport industry lasted for nearly a century and was not forsaken until the passage of the
Baskin, Jonathan Barron, and Paul J. Miranti, Jr. A History of Corporate Finance. New York: Cambridge University Press, 1997. The chapter on railroads provides a good background on nineteenth century railroad financing. Cochran, Thomas C. Railroad Leaders, 1845-1890. Reprint. New York: Russell & Russell, 1965. A biographical look at the contributions of railroad managers. Corliss, Carlton J. Main Line of Mid-America: The Story of the Illinois Central. New York: Creative Age Press, 1951. A great book written for the hundredth anniversary of the Illinois Central. Cullen, E. American Railway Accounting, A Bibliography. Washington, D.C.: Railway Accounting Officers Association, 1926. This is a bibliography of books and articles on railroad management up through 1926. Decker, Leslie E. Railroads, Lands, and Politics: The Taxation of the Railroad Land Grants, 1864-1897. Providence, R.I.: Brown University Press, 1964. Good book on the railroad land grants awarded to the Illinois Central and later railroads. Dilts, James D. The Great Road: The Building of the Baltimore and Ohio, the Nation’s First Railroad, 1828-1853. Stanford, Calif.: Stanford University Press, 1993. This is the premier volume on the history of the B&O. Reynolds, Kirk, and Dave Oroszi. Baltimore & Ohio Railroad. Minneapolis: MBI Publications, 2008. A history of the railroad with many photographs.
Air transportation industry
Railroad strike of 1877
First stagecoach line
U.S. Department of Transportation