Political-Legal Institutions and the Railroad Financing Mix, 1885-1929

Daniel A. Schiffman

Bar-Ilan University

Abstract. During the 19th Century, U.S. railroads relied primarily on debt issues to finance their growth. This policy contributed to major financial crises, beginning in 1857, 1873 and 1893. Nevertheless, railroads failed to reduce their leverage over 1900-1929, and suffered severe consequences during the Great Depression. In order to explain this puzzle, I focus on several key political-legal developments that originated around 1885. These are: (a) Changes in the bankruptcy process; (b) the emergence of large institutional investors, whose holdings came to be restricted by state laws; and (c) an increase in the power of federal railroad regulators, who refused to grant essential rate increases. I construct a counterfactual in order to measure the effects of regulatory policy. I find that railroads would have paid significantly higher dividends, had rates kept up with inflation over 1910-1916.