Corporate Governance, Auditing and the Origin of Information Rights:

The Baltimore & Ohio Railroad 1827-1830

Gary John Previts, Professor Department of Accountancy

Weatherhead School of Management Case Western Reserve University

Cleveland, OH 44106-7235 (216) 368-2074 gjp@cwru.edu

William D. Samson, Roddy-Garner Professor Culverhouse School of Accountancy

College of Commerce and Business Administration University of Alabama

Tuscaloosa, AL 35487-0220 (205) 348-2903

wsamson@cba.ua.edu

and

Dale L. Flesher, Arthur Andersen Professor Patterson School of Accountancy

University of Mississippi Oxford, MS 38677

(662) 915-7623 acdlf@olemiss.edu

CONFERENCE PRESENTATION PAPER PROPOSAL – NOT FOR PUBLICATION

Corporate Governance: Auditing and the Origin of Information Rights:

The Baltimore & Ohio Railroad 1827-1830

ABSTRACT

Attention to matters relating to corporate governance increase in times of capital market stress, decline and turmoil. Recent emphasis by the Congress and other governmental agencies such as the General Accounting Office and the Securities and Exchange Commission on the importance of audit committees of the board of directors raises issues of historical interest. What are the origins and the expectation of audit processes in the contemporary corporate governance? What are the origins of the role which such committees fulfill in financial reporting, internal control, and operating effectiveness? Our research describes primary resource evidence that this role traces back to fundamental by- law provisions in one of the earliest large business enterprises in the US. The work of the audit committee of the Baltimore & Ohio Railroad [B&O] during its formative years indicates that control and reporting activity developed long before the existence of regulatory mandate or the external auditing function. The B&O, incorporated in 1827, established in its by-laws and detailed in its handwritten Board of Directors’ minute books requirements for an audit committee of directors to perform essential audit and control duties. This paper describes the origin, authorization, composition and activities of audit committees which functioned in the early years of the B&O. We present evidence to support our view that the activities of the committee were effective in contributing to the success of the B&O during its developmental stage. We assert that the origins of such control processes in corporate reflect the diverse constituencies providing capital to the company. The involvement of directors who owned shares, reflect the fundamental structure of the private property rights and balances afforded under our constitutional system of capital formation. This process represents the origin of information rights as practiced widely today in a business setting which relies heavily on capital formation through broad public capital markets. The implications for developing a view of such rights is suggested as a part of the conclusion to this historical inquiry.

I. Origins of Accountability: Property and Information Rights

One author asserts that the first known American audit committee was appointed in 1870 by the shareholders of the

East Tennessee and Western North Carolina Railroad [McKee 1979, 61]. This author suggests that the audit committee, made up

of selected shareholders who reported to the Board of Directors, was a business practice of the day, rather than a unique situation

[McKee, 1979, 64]. A 1975 thesis assumes that audit committees first were conceived in the 1930s [Loudal].

Burke and Guy, in their 2001 treatise, Audit Committees: A Guide for Directors, Management and Consultants,

acknowledge finding no discussion about audit committees in the accounting and legal literature of the early twentieth century

[Burke 2001, 9]. These authors reference Kay and Searfoss for the fact that the Prudential Insurance Company of America has

had an audit committee of directors for more than seventy-five years [Burke 2001, 9; Kay 1989, 6-2]. Boockholdt documents the

discovery of an earlier phase of audit history in the U.S.; a history that reaches back to the middle of the 19th century and predates

the development of external auditing and the mid-nineteenth century Companies Acts in the United Kingdom as well as the

earliest known U. S. volume on the subject of auditing, H. J. Mettenheimer’s 1869 Auditor’s Guide.

Boockholdt’s research documents a variety of audit practices in ante bellum American railroads. In particular, the

American audit experience came about through the use of audit committees, especially shareholder audit committees. Such audit

committees served not only as “external” auditors certifying the account balances, they also served internal audit functions

assessing internal control [Boockholdt 1983, 69-86]. Boockholdt cites the use of an audit committee made up of three

shareholders and one director being used to investigate shareholder concerns about management’s presentation of financial

accounts at the Philadelphia and Reading Railroad in 1845 [Boockholdt 1983, 71]. Boockholdt also discovered the use of audit

committees at the Hartford and New Haven Railway in 1846, the Western Railroad in 1851, the Boston and Worchester Railroad

in 1855, the Western Air Line Railroad in 1856 and the New York and New Haven Railroad in 1862 [Boockholdt 1983, 72-73

Our discovery documents the earliest known activity of a US Corporate audit committee two decades prior to

Boockholdt’s identification of the wide spread use of audit committees by American railroads. The B&O, from its beginning in

1827, utilized audit committees of directors to review financial activity. Because the B&O is considered a leading, if not the first

major 19th century American railroad, its operations are known to have influenced others during this phase of the Industrial

Revolution. Indeed Hungerford [1928] documents the appellation “B&O University” to describe how the knowledge of the B&O

was disseminated among other corporations during its early days. Therefore the discovery of the B&O’s audit committee is an

important one, documenting the development of auditing as part of corporate governance by-law structure in the United States.

What issues instigated the use of the audit committee by the B&O? What does Corporate Governance mean? How does

one assess successful governance practices? We trace the origins of accountability to the cultural design of business activity as

found in the U S. Constitution as a political and economic contract, and the role of the corporate charter granted under the powers

reserved for each of the States thereunder. The Constitution affirms the right of the individual to own private productive

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property and to contract it in a manner consistent with the private interests of the owner but with regard to the public rights of the

community. The corporation’s powers as evolving during the 19th century permitted the purposeful accumulation of individual

property under a corporate charter to serve the proprietary goals of the enterprise. The State provided the corporate vehicle as a

means of development of economic well being of its constituents. The risk of said enterprise was assumed by those who

contributed their capital. The B&O corporation charter was issued jointly therefore to form an entity for private gain [profit] and

for the economic [public benefit] development of the City of Baltimore and the State of Maryland. Representatives of those who

provided capital from these sources were represented on the audit committee. The audit committee produced information about

the state of the entity so that those who’s property was at risk were availed of a regular and competent assessment of what was

being undertaken with the property they had entrusted to the enterprise. This notion, represented in terms of traditional

accounting, is referred to as the “stewardship” model of reporting. As such stewardship becomes identified as a fundamental

element of corporate governance in an era and a community where an individual invested property becomes increasingly

controlled by others.

For purposes of our study we consider the Organization for Economic Cooperation and Development’s [OECD 1999]

definition of corporate governance to be useful, namely: “The system by which business corporations are directed and

controlled.” Further we observe the statement of the NYSE/NASD Blue Ribbon Committee [1999] that, “Good governance

promotes relationships of accountability among the primary corporate participants to enhance corporate performance.” We will

take these 21st century notions into consideration as we evaluate the relevance of the 19th century auditing committee in the

B&O’s system of corporate governance.

The paper is organized as follows: The opening section reviewed the political and economic origins of U.S. corporate

accountability, property rights and asserts an implicit recognition of reporting as a response to information rights as part of the

corporate governance process. The rise of railroading and the role of the Baltimore & Ohio during its formative years are

addressed in the next section.

Origins of Accountability: Property and Information Rights

The Rise of the B&O Railed Road

“ROUTINE” AUDIT COMMITTEE ACTIVITY;

Operational Auditing: Construction Cost Control

Reorganization

Summary and Conclusions The next section describes the status of audit history as being traced to the second half of

the nineteenth century in the literature. The paper then describes how the B&O was not just “another corporation”; but a

unique, original interstate corporation, leading the revolutionary transportation changes which occurred during this period of

American history. This leadership role of the B&O makes its use of the audit committee even more significant in the context of

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business and accounting history in the United States. A background section of the paper leads to the story of the B&O’s audit

committees’ experiences during the formative years. This is followed by the section of the paper dealing with the construction

contract controversy and the reorganization of the B&O at the recommendation of a five-man special audit committee. The paper

then examines the role of John B. Morris, who was active on all of the B&O audit committees. . A summary of the findings of

the paper and consideration of future research is presented in the last section.

II. The Rise of the B&O “Railed Road”

Case #8, “The Railroads and the Beginnings of Modern Management,” in Management Past and Present, states that

“Many of the present-day practices and procedures used in the administration of business enterprise were originally devised to

meet the requirements of operating the railroads….” [Chandler et al, 1996, 2-20]. Our working thesis will afford a partial

assessment of this proposition as to the auditing processes employed by one of the earliest and arguably the first interstate and

common railroad carrier, the B&O.

The Baltimore and Ohio (B&O), formed in 1827, was “the first important railroad project undertaken in the United

States” [Cleveland 1909, 61]). What made railroads modern businesses was their scope of operations and the capital requirements

which were far in excess of contemporary enterprises. This, in turn, meant that external financing had to be sought to construct a

railroad line. While other contemporary businesses were owner-operated, family ventures requiring loans, commonly, for

seasonal financing, railroads, by contrast, with the long-term capital needed to construct a line, excavate, bridge, tunnel, fill, lay

track, and equip with rolling stock, required more capital than a single person or family network could readily manage; so many

individuals, including both debt and equity investors external to the railroad operations, were needed to provide capital. This

created new issues of what information to provide and how to communicate with investors regarding the performance of the

railroad as well as how to monitor those with responsibility for managing the enterprise suggests that fundamental concerns about

private property rights and information are inherent elements to be addressed by governance.

The B&O’s equity capital formation process involved selling shares of stock to Maryland businessmen and citizens, to the State

of Maryland, and to the City of Baltimore, to fund the construction of a railed road across uncharted mountains and rivers using

untested technology and incomplete plans. [Would anyone doubt it had the capacity to be the ENRON of its day?] It was the

city’s strategic response to planning it role as an Atlantic port of entry to the new lands of the American West. Baltimore had

relied on the National Road and wagon and Stagecoach transport. These means became noncompetitive with the opening of the

Erie Canal. Richmond and for time even Philadelphia, opted to replicate canal technology. Richmond sponsored work on the

Chesapeake & Ohio Canal. Because Baltimore did not have a direct river access to the west, merchants of Baltimore were willing

to consider any and all ideas. Banker Philip E. Thomas had been corresponding with his brother, Evan Thomas, who was in

England and who was excited about “railed roads” there. Similarly George Brown, an investment banker, had been hearing from

his brother, William, in Liverpool, about British railroads [Dilts 1993, 37]. Baltimore chose the riskier, innovative approach, the

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“railed road” powered by horse teams. Incorporation of the venture was done via special enactment by the Maryland legislature

in February 1827. Passage of similar incorporation acts in neighboring Virginia and Pennsylvania followed. Thirty thousand

shares of $100 stock were quickly subscribed to as virtually every citizen of Baltimore supported the enterprise [Jacobs 1995,

13]. City of Baltimore and State of Maryland funds also were invested as these entities received half of the ownership (5,000 and

10,000) of the shares, making the B&O a quasi-public, quasi-private entity. The scale of the proposed B&O enterprise, would

eventually surpass the capital employed in the Erie Canal [at $8 million of state funds], rising to $30 million by the time the B&O

reached the Ohio River 25 years later. An investment of this scale could only be attempted if it was to be well accounted for and

controlled. An annual report (“Statement of Affairs”) issued by the corporation to its shareholders was required by the B&O

corporate charter; though, the contents of the annual report were not specified [Previts 2000, 5]. In time, financial statements

within annual reports became the objective function of the corporate accounting process [Chatfield 1974, 222]. Further, given

the engineering talent involved in developing new railroad technology, their analytical skills also identified the elements needed

for managerial accounting techniques which would produce cost-volume-profit analysis [Flesher 2000, 93-94]. Behaviors of

fixed and variable (“floating”) costs were identified and evaluated almost as soon as the first 13 miles of B&O track were being

used to run trains. Understanding these cost elements would become important since recovery of cost required adequate rates, and

while the act of incorporation indicated the B&O would pay no taxes, it also specified that the Maryland legislature would set

freight and passenger rates.

Cost overruns, evidenced by excessively high cost per mile (more than three times the budget) meant the company ran out of

money and sought out founders for “bailout” loans and its shareholders for an assessment of its capital stock subscription. Such

circumstances made control over construction outlays important. Since these episodes occurred while the B&O Railroad track

was being built for only a short distance over relatively easy terrain, achieving effective controls over cost and preservation of

capital was critical to the company’s goal of reaching the Ohio River.

III. “Routine” Audit Committee Activity

From the beginning, the incorporators of Baltimore recognized in an original 1827 by-law, the need for

accountability, even before making the first expenditures to construct the railroad. They established a quarterly review by a

director’s audit committee as a key element of corporate governance and specified the timing and scope of the regular audit

function required. The “Code of By(e)-Laws”, adopted April 9th, 1827, states:

3rd A Committee shall be appointed at least once in three months to inspect the accounts and funds of the Company and to

examine the vouchers for all monies expended and shall report the same.

The B&O routine quarterly audit committee activity produced an “audit report”, with exceptions noted

therein. Also, operational audits as well as internal control issues were addressed in later assignments to the group which was

expanded to serve in the role of a special audit committee to investigate administrative matters. The routine audit committee

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examined the “treasurer’s reports”, while a larger committee of directors, including the routine audit committee members,

examined problems with construction expenditures. Documentation for such expenditures was poor, payments had been made in

advance of work done, and also payments were made beyond contracted amounts. Internal disputes occurred between the

Construction Superintendent and the Board of Engineers about the lack of control and over procedure. Table 1 below contains an

overview of the reports of the audit committee of directors which are contained in the B&O Minute Book. This overview details

when the reports were issued and when the audit took place. The table also indicates this paper’s exhibit number for each of

these reports.

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TABLE 1 OVERVIEW OF REGULAR AUDIT REPORTS

Report Date Audit Date Exhibit # October 1, 1827 September 29, 1827 1 May 8, 1828 -- - July 11, 1828 June 30, 1828 2 October 4, 1828 September 30, 1828 3 April 7, 1829 January 1, 1829 4 April 27, 1829 April 1, 1829 4 September 4, 1829 July 1, 1829 4 November 12, 1829 October 9, 1829 5 December 31, 1829 September 30, 1829 6 March 31, 1830 January 20, 1830 7 June 30, 1830 April 1, 1830 8

After the adoption of the corporate “Code of Bye Laws” at the April 9th 1827 meeting, the Board of Directors met on

September 8th, 1827 and appointed two of the directors, John B. Morris and William Stewart, to examine the “Treasurer’s

accounts” and to report their finding to the Board at the next meeting [Minute Book A, p. 30].

The committee’s report, reproduced below, is particularly noteworthy for it is the first known U. S. audit statement.

Exhibit 1

Meeting of the Board 1st Oct 1827 Report of the Committee Appointed to examine the Treasurer’s a/c 1827 Oct. 1 We have examined the foregoing a/c & find the same to be correct exhibiting the amount

rec’d by the treasurer of the Railroad & the several disbursements authorized by the board by which it will appear there remains a balance of $17,835.9/100 at the credit of the company as p[er] book balances on the 29th of September [with] satisfactory vouchers being produced to show the correct refs of the afore said disbursements.

Signed John B. Morris William Stewart [Minute Book A, Board of Directors Meetings, 31-32]

In the exhibit 1 material, it is noted of the fact that while the audit report stated “9/100”, the statement reflecting the

account balance actually showed “19/100”. It is indeed significant to find vouchers being used to support the company’s

disbursements and that the Board of Directors had authorized all of these payments. Certainly, these internal controls, along with

the audit committee’s examination, were techniques to assure that assets were safeguarded.

A similar report was again given at the May 8th 1828 meeting of the Board of Directors.

For the end of June 1828 quarter, an audit committee, this time consisting of John B. Morris and Patrick Macaulay,

instead of William Stewart, was appointed to examine the Treasurer’s accounts. The committee’s report is given in Exhibit 2.

Emphasis has been added.

Exhibit 2

The foregoing account/recorded in a/c curt Book fol 3) has been examined and found to be correct and supported by the necessary vouchers by which it appears that a balance of Thirteen thousand two hundred

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fifty six dollars and forty four cents remained in the hands of the Treasurer on this 11th day of July exclusive of the installments now paying in and the sum of Six thousand three hundred & forty five dollars and fifty five cents charged to the Government of the United States and which is expected to be refunded as per Balance Sheet in act/rcd herewith furnished.

The Committee to whom was [re]ferred the examinations of the accounts of the company for the quarter ending the 31st June 1828 beg leave to Report that they have found them correct and supported in all case by the necessary vouchers. The Treasurer’s account will exhibit the Balances now in hand and the amounts to be audited by the Government of the United States with the certificate (copied above) thereto of the Committee. The Committee deem it proper to inform the Company that a charge of 2 ½ p[er] cent has been made by some of the Engineers engaged in active duty upon the amounts disbursed through their hands, this charge has been allowed by the President of the Company as being in conformity with the established usage in similar cases in the Service of the general government.

Signd John B. Morris Patrick Macaulay [Minute Book A, Board of Directors Meetings, 138-9]

This report uses the term “audited” for the first time. Interesting as well, are the words “in conformity”, in this case

with the practices of federal governments. The use of these terms is of historical interest as milestones in the evolution of

auditing. While it is perhaps stretching a point, “certificate” seems close to the current term “certify”.

Again in the exhibit, minor errors are noted: the date “June 31st” was meant to be “June 30th.” Two other matters of

interest, in addition to the terms “audit” and “conformity”, were mentioned in the report. First was the fact that some engineers

had been charging the B&O a 2½% fee for processing payments under their control. This practice, apparently, was customary

during their federal government service. The audit committee reported the practice met with acceptance by the B&O President,

Philip E. Thomas. Secondly, the receivable of $6,345.55 for costs which the B&O paid, was to be provided by the federal

government. This charge for surveying would appear on several quarterly audit reports before it was eventually collected.

The audit committee rendered a “two paragraph” report to the Board of Directors for the next quarter. It is reproduced

in Exhibit 3, below. The relationship between the paragraphs is hypothetical at this point, but the first paragraph appears to

resemble a “scope” of the examination and the second seems to be the “opinion” paragraph. This structure seems familiar to the

modern “two paragraph” audit opinion; however, this observation is rendered with reservation.

Exhibit 3

Report of the Committee appointed to inspect the Treasurers accts for the 3rd quarter of 1828 The Committee appointed to inspect the accounts and funds of the Company and to examine the vouchers for

all monies expended agreeably to the 3rd article of the Bye Laws produces the following report & statement to which being read was accepted to wit: The within account recorded in a/c with curt Book/fol 5 has been examined and found to be correct and supported by the necessary vouchers by which it appears that a balance of seventy seven thousands nine hundred & fifty seven dollars & forty four cents remained in the hand of the Treasurer on the 1st day of October exclusive of the installment now paying in and the sum of Six thousand three hundred & forty five dollars & fifty cents charged to the Government of the United States & which it is expected to be refunded as fd Balance Sheet marked & herewith furnished.

John B. Morris Patrick Macaulay

The committee to whom was referred the examination of the accounts of the Company for the Quarter ending the 30th of Sep 1828 beg leave to report that they have found them correct and supported in all cases by the

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necessary vouchers. The Treasurer’s account herewith transmitted exhibits the balance now in hands together with the amount to be obtained from the government of the United States

All of which is respectfully submitted.

Oct 4 1828 John B. Morris Patrick Macaulay Committee [Minute Book A, Board of Directors Meetings, 148]

At the December 28th 1828 meeting of the Board of Directors, as the last item of business, the “Committee to Examine

& Report upon the Treasurer’s accounts” (according to the provisions of the 3rd article of the “Bye Laws”) was appointed. Both

John B. Morris and Patrick Macaulay were continued in their memberships on this committee; and William Stewart, who had

served previously, was reappointed to the committee. This expansion to three members reflected the agreement that the Company

would appoint two directors and the city of Baltimore (a major holder of stock) would appoint one director to this committee.

Given the financial backing by the city of the B&O enterprise, this appointment power over the audit committee reflects how

important this committee was in the financial administration of the venture.

The audit committee issued three reports to the Board of Directors, from April to September. These are grouped

together in Exhibit 4. During these three separate periods, the government receivable remained unpaid, and the cash balance

exhibited substantial volatility from $64,444.44 to $92,448.97 three months later and then to only $20,726.55 three months

afterward. While the audit reports did not call attention to these cashflows, the fact that the cash outflow was supported by

vouchers documenting the validity of the payment must have reassured the Board of Directors.

Exhibit 4

The Committee appointed to inspect the accounts and funds of this Company and to examine the vouchers for all monies expended “agreeably to the 3rd article of the Bye Laws produced the following report and statement [emphasis added] which being read was accepted to wit.

The within account/recorded in a/c curt Book/a) has been examined and found to be correct & supported by the necessary vouchers, by which it appears that a balance of Sixty-four thousand Four hundred and forty four dollars and forty four cents remained in the hands of the Treasurer on the first day of January 1829 exclusive of Six thousand three hundred forty five dollars and fifty five cents charged to the Government of the United States and which is expected to be refunded.

7th April 1829 John B. Morris

William Stewart Patrick Macaulay Committee

The within account/recorded in a/ current B page has been examined and found to be correct and supported by the necessary vouchers by which it appears that the balance of Ninety two thousand four hundred and forty eight dollars and ninety seven cents remained in the hands of the Treasurer on the first day of April 1829 exclusive of Six thousand three hundred and forty five dollars and fifty five cents charged to the Government of the United States and which is expected to be refunded

27th April 1829 Patrick Macaulay

John B. Morris William Stewart Committee [Minute Book A, Board of Directors Meetings, 178-180]

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The within account has been examined and found to be correct and supported by the necessary vouchers by which it appears that a balance of twenty thousand seven hundred and twenty six dollars and fifty five cents remains in the hands of the Treasurer on the first Day of July 1829 exclusive of six thousand three hundred and forty five dollars and fifty five cents charged to the Government of the United States and which is expected will be Refunded

September 4th 1829 John B. Morris Patrick Macaulay Committee [Minute Book A, Board of Directors Meetings, 202-203] In exhibit 5, below, the Audit Committee’s report, dated November 12th 1829, found the Treasurer’s cash balance to be

$83,922.74 for October 9th 1829, up considerably from the first of July balance of slightly over $20,000. The federal government

still had not reimbursed the B&O for the $6,345.55 it owed.

In exhibit 6, below, there is a letter from the President transmitting the accounts and vouchers to the audit committee.

Thus, the President is, in effect, being audited by the committee. The rest of the exhibit is the committee’s audit report which

found the account balances correct and supported by documentation. The report does reference exhibits including a balance sheet,

which accompanied the committee’s report. This had not been done in previous reports. Interestingly, the annual report to the

stockholders did not include a balance sheet until 1840 [Previts, p. 28]. In the audit report, the accounting for the discount on

notes is questioned as an audit “exception”.

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Exhibit 5 The following Report was received from the Committee of the Treasurer accounts and was accepted. The within account has been examined and found to be correct and supported by the necessary vouchers, by

which it appears that a balance of Eighty three thousand nine hundred and twenty two dollars and seventy four cents was due to the Treasurer on the ninth day of October 1829, and that the sum of six thousand three hundred and forty five dollars and fifty five cents charged to the government of the United States was still due the Company & which is expected to be refunded.

November 12th 1829 Patrick Macaulay J. B. Morris Committee Wm Stewart [Minute Book A, Board of Directors Meetings, 234]

Exhibit 6

The accompanying accounts of disbursements on a/c of the Baltimore & Ohio Rail Road for the quarter

ending 30th Sept. 1829. Having been examined by the Clerk and reported to me as correct, are approved, and transmitted for your examination to P. Macaulay Respectfully P. E. Thomas Pt

John B. Morris B&O R.R. Co. Wm Steward Esqrs Com.e of Examination The Committee to whom was referred the accounts of the company beg leave to Report that they have

examined the accounts for the third quarter of the present year laid before them and approved by the President of the Company as per document A herewith transmitted and have found them correct and in all cases supported by the necessary vouchers. It will be observed by a reference to document B herewith transmitted including the account current and balance sheet [emphasis added] from the Treasurer that the sum of Eighty three thousand nine hundred and twenty two dollars and seventy four cents appears due to the Treasurer but which in fact did not exist, as it arose from the discount of notes placed in his possession by the Board of Directors all of which has been since paid.

Respectfully submitted December 31st 1829 signed P. Macaulay J. B. Morris Wm Stewart Committee [Minute Book A, Board of Directors Meetings, 283]

Exhibit 7

The Committee who were charged with the examination of the accounts beg leave to report that they have performed that duty up to the quarter commencing with the first of January of the present year –

They have found the accounts correct with the exception of one Dollar and eighty six cents which appears to have been overpaid to Labourers in the Settlement of Lieut Whistler’s account for laying Rails. Postage Bills to the amount of $54.49 have also been paid by the Company for the last quarter; it does not appear to the Committee that the amount so charged and paid was wholly for the services of the Company – they would therefore recommend that Postages in the future should only be paid as a contingency by the production of a regular voucher. Which is respectfully submitted.

March 31st 1830 /signed/ P. Macaulay J.B. Morris [The account is entered in Account Current Book folio 8] The within account has been examined and found to be correct and supported by the necessary Vouchers by

which it appears that a balance of sixteen thousand one hundred and three dollars and forty eight cents remained in the hands of the Treasurer to the Credit of the Company on the twentieth day of January 1830.

March 31st 1830 /signed/ P. Macaulay J. B. Morris

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[Minute Book A, Board of Directors Meetings, 298-299] In the reports detailed in Exhibit 7, the audit committee pointed to two cash expenditures, which it felt, were incorrectly

paid. Apparently, laborers had been overpaid by $1.86 by the B&O. This seems very minor, but reflects the care with which the

committee undertook its work. The second item, postage of $54.49 must have been for employees’ personal mail, which the

B&O paid for. The audit committee recommended a voucher system to ensure that only company postage was paid for by the

railroad.

The reports of the audit committee, dated June 30th, are the last “regular” audit committee reports for the formative

period of the B&O. These two reports are shown below in Exhibit 8. As with the previous reports, the audit committee certified

that the accounts were correct and vouchers documented the company expenditures.

Exhibit 8

The Committee to whom was referred the accounts of the Company report – That they have examined the accounts for the first quarter of the present year which have been laid before them and approved of by the President of the Company and found them correct in all cases and supported by the necessary vouchers. It will be seen by reference to the Account Current of the Treasurer that on the first day of April, a balance of Twenty five thousand six hundred and fifty dollars and thirty seven cents, was charged to the company. The notes placed in the possession of the Treasurer upon which this amount was raised having been paid this amount will be carried as the Credit of the Company the ensuing quarter.

Respectfully submitted /signed/ P. Macaulay J. B. Morris June 30th 1830 (The account is entered in Account Current Book folio.) The within account has been examined and found correct and supported by the necessary vouchers by which

it appears that a balance of twenty five thousand six hundred and fifty dollars and thirty seven cents was due to the Treasurer on the 1st day of April 1830.

/signed/

P. Macaulay J. B. Morris June 30th 1830 [Minute Book A, Board of Directors Meetings, 328-329]

In Table 2 below, the B&O audit committee reports are compared and summarized. Noteworthy is the fluctuations in

cash which, no doubt, was a major point of discussion for the directors at the meetings. Given that the company was in the

development stage with no revenue from operation, construction expenditures were THE CONCERN. Raising capital from

shareholders and from lenders were the only cash inflow sources to make up for the cash outflows spent on construction. Cost

overruns would plague the building of the B&O, as the next section will describe in depth.

TABLE 2 COMPARISON AND SUMMARY OF REGULAR AUDIT REPORTS

Report Date

Audit Date

Cash Balance Committee Members

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October 1, 1827 September 29, 1827 $17,835.09 John B. Morris , & William Stewart May 8, 1828 -- -- John B. Morris, & Patrick Macaulay July 11, 1828 June 30, 1828 $13,256.44 John B. Morris, & Patrick Macaulay October 4, 1828 September 30, 1828 $77,957.44 John B. Morris, & Patrick Macaulay April 7, 1829 June 1, 1829 $64,444.44 John B. Morris, William Stewart, & Patrick

Macaulay April 27, 1829 April 1, 1829 $92,448.97 Patrick Macaulay, John B. Morris, & William

Stewart September 4, 1829 July 1, 1829 $20,726.55 John B. Morris, & Patrick Macaulay November 12, 1829 October 9, 1829 $83,922.74 Patrick Macaulay, John B. Morris, & William

Stewart December 31, 1829 September 30, 1829 $83,922.74 Patrick Macaulay, John B. Morris, & William

Stewart March 31, 1830 January 20, 1830 $16,103.48 Patrick Macaulay, & John B. Morris June 30, 1830 April 1, 1830 $25,650.37 Patrick Macaulay, & John B. Morris

IV. Operational Auditing: Construction Cost Control

The B&O began construction in 1828, a year after it was formed. Much had to be done and much was undertaken at

once, yet an organization with capability to accomplish the various tasks was not yet in place. Learning by doing must have been

the normal procedure. With the stock subscribed to, and with survey crews mapping the terrain for possible routes to the Ohio,

engineers and construction groups were hired in the spring of 1828. Jonathan Knight and Casper Willis Wever, who had worked

together on the National Road as Commissioner and as Superintendent of Construction, respectively, were hired to build the

B&O [Dilts 1993, 62-3]. On the B&O, Knight was employed as an engineer while Wever was appointed the Superintendent of

Construction. Wever did not start immediately; he needed several months to get his personal affairs in order. When he arrived to

take charge of construction, building had already commenced.

At about the same time Knight and Wever were hired, the B&O also hired Colonel Stephen H. Long and Captain

William Gibb McNeill as engineers given their topographical expertise being needed to locate the best routes over the

Alleghenies. Knight, Long and Philip E. Thomas, the B&O President, became the Board of Engineers (BOE). This unit’s

formation and role were mysterious; no known official explanation of its role or idea for origination has been found. Dilts, the

foremost authority, postulates that the idea may have come from the Engineers themselves or that the idea for a Board of

Engineers may have been carried over from a government model of a panel of engineers as used in constructing forts and internal

improvements [Dilts 1993, 75]. The BOE acted in the capacity of overseeing the railroad construction. It soon clashed with

Superintendent Wever, who was in charge of construction and a person not suited to being thus supervised.

The Board of Directors decided to commence building on July 4, 1828, with much fanfare as marked by a great “laying

the stone” ceremony. The Board of Engineers published notices calling for proposals from contractors to bid on grading and

bridging. The contract procedure followed the pattern, that was used by the federal government, and the BOE oversaw the initial

contract work, since Wever, who had been hired, had not yet arrived to supervise.

13

Following the U.S. Corps of Engineers experience, the Board of Engineers delegated Capt. McNeill to draw up

regulations governing construction contracts [Dilts 1993, 75]. These regulations adopted on June 9th 1828 are given below in

Exhibit 9.

14

Exhibit 9

Selected Regulations of the Board of Engineers

Article 4: calls for appointment of superintendent of construction who would receive all his instruction from the Board of Engineers

Article 7: dictates the manner of keeping and rendering accounts for disbursement, quarterly

abstracts, accounts current and disposition to be made of them. It provided for examination of records by the Board of Engineers

Article 8: sets standards of responsibility for company employees to whom funds or other property

of the company had been entrusted Article 9: specifies the duties of the Treasurer and the Committee on Accounts in the relationship to

fiscal operations Article 10: requires the Committee on Accounts’ report to be in writing, and to express an opinion as

to the proper or improper application of funds of the company Article 11: requires that any funds spent based on estimates must be approved first by the Board of

Engineers. Payments for contracts made when contracts fulfilled – only paid by Treasurer on order by President after certificate given by Board of Engineers who inspected the work and certify that the contract has been fulfilled.

[Articles extracted from Long and McNeill’s Narrative of the Proceedings of the Board of Engineers, 1830, 29-30] These regulations were approved by the Board of Engineers by a vote of 2-1 – with Thomas and Knight approving and Long

voting against (he felt the articles were not explicit enough) [Long 1830, 34].

Apparently, cost control and quality assurances were the objectives of the Board of Engineers’ regulations. The

“Committee on Accounts,” while not described further, is likely to be a reference to the Board of Director’s audit committee,

given the subsequent use to which that Committee was put by the BOE.

Wever was appointed Superintendent of Construction on June 20, 1828, but was delayed several weeks from assuming

this position. When Wever took over the Superintendent’s job, he immediately insisted that he have control over all grading,

masonry and bridge work without any interference from the BOE. He also insisted on being able to relocate the road and control

the payment of contractors [Long 1830, 35-36]. While Col. Long opposed Wever’s demands, Thomas and Knight supported

Wever. Long feared that if the Board of Engineers did not monitor and control Wever that the Engineers would be held

accountable for cost overruns. Thomas, on the other hand, felt that the BOE already had sufficient work before them, being

charged with establishing the route to the Ohio. Therefore, on August 2, 1828, the Board of Engineers, in a two-to-one decision,

agreed to allow Wever to operate construction without direct BOE oversight [Long 1830, 58]. However, the BOE did require

Wever to render a first-day-of-the-month detailed progress report to it and also expected Wever to request permission of the BOE

to make changes in any construction plans [Dilts 1993, 76].

At the end of September 1828, the BOE made estimates of costs of construction in a report to be included in the annual

report to shareholders. In its report, the Engineers wanted to present reassuring projections on cost per mile of grading and

15

bridging. These projections about the “cost per mile” were important because the C&O Canal had already encountered substantial

cost overruns in its construction. Long and Knight estimated the cost per mile to be $7,000. President Thomas estimated

construction at $3,500 per mile [Long 1830, 64]. Such estimates became suspect and embarrassing as the actual costs continued

to run much higher. When McNeill was selected to replace Thomas on the Board of Engineers, thereafter charges of

mismanagement were directed against Wever by the BOE, which now had two of its members (McNeill and Long) in opposition

to the Construction Superintendent.

Because Knight, McNeill, and George Washington Whistler were leaving in November 1828 for a seven-month

extensive investigation into all aspects of British railroad operations, the BOE elected its remaining member, Col. Long, to be

President of the Board. To direct Wever’s actions, the BOE then passed requirements for closer accountability over

disbursements; required estimates of monthly expenditures to be submitted to the Board of Engineers for approval, and required

vouchers to be used for all disbursements [Long 1830, 83].

Wever ignored the BOE resolution. He gave the Board his estimates, but without details or accounts [Long 1830, 86].

He requested $30,000 be paid to contractors, but provided no documentation to support the payments. The BOE felt that the

Superintendent was challenging the Board’s authority. President Thomas, though, supported Wever, and directed that the BOE

not interfere with Wever. President Thomas had Wever report directly to himself. Thomas then assigned Long the responsibility

of completing the western survey for the route of the railway [Long 1830, 101-105].

Nonetheless, in the last quarter of 1828, the BOE (Col. Long) found Wever’s accounts were “informal and defective”

and “not rendered in accordance with provisions of regulations for the Engineering Department” [Long 1830, 118]. Further,

Wever was found to have made payment to contractors without voucher documentation to support the payment, that is, no

physical measure of the work done had been made before making payment. Wever had not submitted estimates of cash payments

he would be making in January 1829, nor had he provided information to the Board of Engineers about the progress of

construction, quantity of work done, and amounts that needed to be paid. The Board of Engineers became especially concerned

over Wever’s practice of making advances to contractors, while using vouchers to serve as mere receipts of money paid with no

measure of work done or object of the payment [Long 1830, 119-137]. Long criticized Wever’s expenditure procedures for

lacking specifics about the nature, quality, price and circumstances surrounding expenditures [Long 1830, 138]. Wever defended

his practice as meeting the accounting standard for disbursement of funds on the construction of the National Road, which were

larger dollar amounts – hundreds of thousands of dollars – without such record-keeping demands now being placed on him [Long

1830, 138]. Dilts notes that Wever had been responsible for paying Contractors on the National Road significant sums of money.

Apparently, Wever had a habit of poor record keeping there too [Dilts 1993, 63]. (Dilts further notes that at the National Road,

Wever had the authority to dictate the exact location of portions of the road; so Wever’s actions at the B&O were not inconsistent

with his previous job [Dilts 1993, 63].)

16

To resolve the charges that Col. Long had made against Wever, the Board of Directors directed the Audit Committee to

examine the Superintendent of Construction’s contracting system.

The Audit Committee of Directors (i.e. “Committee of Accounts”) gave Superintendent Wever support in the report

issued April 27th, 1829. This report vested the Superintendent with control over the construction contracts, free from interference

of the Board of Engineers. Exhibit 10 contains the entire report of the Committee.

Exhibit 10

THE AUDIT OF THE SUPERINTENDENT OF CONSTRUCTION

The Committee to whom was referred (sic) the Accounts of the Company beg leave respectfully to report that they have examined the accounts laid before them for the last quarter of 1828 and the first quarter of 1829 and found them correct and supported by the necessary vouchers. They deem it however advisable to lay before the Board of Directors the following statement in relation to the accounts. The committee has found the expenditures in the Superintendent’s department in all instances supported by receipts signed in duplicate for the amounts paid to the contractors for work done in construction and for other matters where services have been rendered or articles purchased. The requisite certificate was also appended that they had been necessary for the service. These accounts which appear to the Committee perfectly correct have nevertheless not met the sanction of the President of the Board of Engineers in consequence of a supposed informality resulting (as he states in the document marked A herewith transmitted) from actual measurement being required for all work done whether completed or not and transmitted as a portion of the voucher for the amount paid. Under the 7th rule for the regulation of the Engineer department the board of Engineers are charged with the examination of the accounts, but it appears to the Committee that their approach [is] exclusively the duty of the President of the Company: this subject they beg leave respectfully to refer to the decision of the Board of Directors.

The Committee are fully aware of the great importance of a faithful discharge of the duties of the Superintendent’s department but they are unable to discover what particular good is to result from an actual measurement being made in all cases for work done, before the contractor can be provided with the necessary means for continuing his operations on the contrary the numberless agents which such a system would require to carry it into effect must greatly diminish the funds of the Company, and tend to retard the work. In the settlement of the accounts which have just been passed by the Committee they have in all cases found where a final payment had been made that the Company was in arrears to the contractor nor does it appear that the amounts which have been advanced to the contractors have in any instance exceeded the work done on a final settlement. The Committee does not hesitate to believe that the work will be greatly facilitated by the system, which the Superintendent has adopted, and that full reliance should be placed in his judgment and faithfulness in the discharge of his duties.

The document marked B herewith furnished will show the state of the funds of the company with the receipts and expenditures up to the 1st April 1829. All of which is respectfully submitted

Patrick Macaulay 27th April 1829 John B. Morris William Stewart Committee

[Minute Book A, Board of Directors Meetings, 202-203]

Despite the “clean bill of health” which the audit committee of directors had given Wever and despite the support for

Wever by President Thomas, the Board of Engineers felt Wever was operating recklessly. Long and McNeill, who had returned

from England in May 1829 and replaced Thomas on the Board of Engineers, sought to control Wever. In particular, the BOE was

concerned about the expenditures that were evident as Wever changed specifications for bridges from wood to stone, lengthened

bridges without consultation, built bridges without drawings and plans, and moved and adjusted routes as he saw fit. Long

discovered that the cost accounts and financial records were incomplete and refused to authorize payments to contractors unless

17

the documentation improved. Wever bypassed the BOE and got the Board of Directors to authorize payment to the contractors,

resulting in a $20,000 to $30,000 cash outflow per month for uncertain expenditures which could not be precisely linked to

specific work or contracts [Dilts 1993, 76].

By June 1829, Wever decided he needed the help of the Board of Engineers. He requested that the Board support his

recommendation that the contractors be paid amounts over and above their contracts to underwrite the losses, which they were

encountering. Wever feared if the contractors suffered losses, that they would walk away from the contract, leaving men idle and

unpaid, and work stopped. With news of such losses, new contractors would be discouraged from bidding on work. Wever

pointed out that the contractor’s losses were due to the almost 50% unforeseen rise in labor cost during the past year, changes

made in the plans, and unanticipated difficulties such as encountering rock and clay which caused added costs in excavation. The

Board of Engineers approved Wever’s request for assistance and set out to determine the additional amounts to be paid to the

contractors.

Whistler and McNeill examined the work done on the line from the city of Baltimore to the end of the second division,

at the Patapsco River. They felt that an additional $45,000 should be paid to the contractors [Dilts 1993, 77]. The Board of

Directors agreed. However, the B&O did not have the money. This caused the directors to call for a $5 per share payment on the

stock subscription, payable by November 1829. To support the call for more capital, Thomas felt he needed more information

about the cost of construction so he had the Engineers examine what it would take to complete the section and thereafter revise

the estimates. The Engineers obtained information from Wever about masonry costs on bridges. For the thirteen miles from

Baltimore to Ellicott’s Mill, the cost was $37,500 per mile. Estimates a year earlier of $7,000 per mile (Long and Knight) and

$3,500 (Thomas) now appeared to be poorly done. The first thirteen miles crossed flat tideland. Mountains and gorges loomed

ahead. What would the cost per mile be? Worse – the company was out of money and only thirteen miles of track had been

constructed. The Ohio River was becoming very distant.

In September, Wever surprised the Board of Directors again when he told them that he would need $180,000 to finish

the first two divisions of the railroad and that this amount was needed within the next three months. Since the B&O had only

$20,000 on hand, the “Merchant Princes” directors who had direct banking connections scrambled to raise money. William

Patterson, Robert Oliver, Alexander Brown and President Thomas rescued the B&O. Eight directors (themselves included)

signed $12,500 promissory notes, which the B&O discounted for cash at a bank. The cash inflow carried the B&O until the

subscription payments were received from shareholders [Dilts 1993, 78].

Long felt that the costly surprise was Wever’s responsibility. Wever had been withholding the true numbers,

deliberately underestimating the cost of construction and falsifying reports. Wever admitted as much, saying that he “may have

lied” [Dilts 1993, 77]. However, it seems very likely that Wever did not know what the costs were and how much the cost

overruns were. The Board of Engineers launched an investigation into the bridge construction. The Board found that Wever

18

relied on verbal rather than written contracts with the contractors and that the bridges were being built without plans, and that

they were being designed as they were being constructed [Dilts 1993, 77].

Long drafted another set of bylaws governing engineering and construction for the BOE. These new rules would strip

Wever’s power to pay contractors and shift the disbursement authority to the Board of Engineers. However, President Thomas

vetoed Long’s actions. He did so because the price of B&O stock was falling due to the cost overruns and the new stock

assessment. Thomas feared another controversy would reduce the price of the stock further. When McNeill demanded Wever’s

removal, Thomas’ reaction was negative – he seemed anxious to limit the Board of Engineers instead. If the Engineers revealed

the true costs of the bridges, the overruns would shake the investors’ confidence so badly that the stock price would plummet and

that a secondary offering of shares could not be made [Dilts 1993, 77].

However, in the B&O’s third annual report, issued October 1829, both Thomas and the Board of Engineers reported on

the cost overrun problems in separate letters to shareholders. By December 1829, Thomas and the directors appointed a special

five-man committee to review the Superintendent of Construction and the charges, which McNeill had made against him. At the

January 30th, 1830 meeting of the Board of Directors, a special organizational audit committee appointed to investigate McNeill’s

charges reported its finding. This report is included in its entirety in Exhibit 11.

Exhibit 11

The committee appointed to examine into the charges preferred against the Superintendent of Construction in relation to the discharge of his official duties produced the following report which was accepted to viz: The undersigned Committee appointed on the 3rd day of November 1829 to investigate certain charges preferred against the Superintendent of Constructions by Capt. Wm. G. McNeill as contained in his communication bearing date 31st Oct have been bestowed a patient attention on the same….: In this, that he [SoC] did in several instances on or about the first of July 1829 knowingly make misstatements in this official return of the contract prices.

The committee take this occasion to remark that it does appear [the contrary is not alleged] that the

Superintendent has honestly and satisfactorily accounted for every sum that has been placed in his hands uniformly furnishing clear and satisfactory vouchers for every payment made in the service of the Company----neither does it appear that in any instances his payments to contractors have been made beyond the amount due and they have not learned that upon the termination of the work the company have ever sustained a loss by being in advance of the work actually executed. The omission to reduce contracts to writing on the part of the Supert does appear to have been loose and different from what should have been strictly adhered to which it is believed was the result of circumstances. In all future operations it would be advisable to conform thereto as far as the perpetual changes of contracts and contractors will permit an observance of such a course if there be cause of blame against the Supt. The Committee believes the Supt has greater claims to approbation

December 22nd, 1829 Directors Morris, Brown, Macaulay, Magruder and Lucas as signing members. [Minute Book A, Board of Directors Meetings, 235-237]

The first report absolved Wever of the charges of the Engineers. The same special organizational audit committee then issued a

second report. It is given in Exhibit 12. In this report, the committee recommended the termination of the Board of Engineers and

a restructuring of the governance and organization of the B&O.

Exhibit 12

19

The Committee appointed in October last to examine into the application of the funds of this Company and to inspect the work as far as it has been executed and who were also desired to inquire if an improvement could not be made in the organization of its officers, produced the following Report which was accepted and the several recommendations therein proposed were unanimously approved.

The Committee appointed at the stated meeting of the Board on the 5th of October last “to examine into the

operations of the company for the last year, to revise and inspect the various expenditures which have been made, and the manner in which the work has been executed and who were also desired to report their opinions whether under the experience acquired any improvement can be made in the organization for carrying on the business of the company, or in the administration of its affairs” now beg leave to report inpart that they have given considerable attention to the important subject committed to them and are unanimously of the opinion that an “improvement may be made in the organization for carrying on the business for the company and in the administration of its affairs.”

They therefore agree in recommending the immediate dissolution of the Board of Engineers and a suspension

of the salaries of all the officers attached to the Engineer Department, with the view of affording an opportunity to the Board of effecting an entire change in the organization of that branch of the service. And they also recommend the repeal of all the rules and regulations heretofore adopted by this Board for the government of the Engineers Department.

The committee asks for further time to report upon the other subjects submitted to their consideration and

recommend the adoption of the following resolution. RESOLVED that an Executive Committee consisting of three members of this Board be appointed to take

charge of the Engineer Department, the Archives, papers etc and the general concerns of the Company, until the future organization be fixed upon by the Board of Directors.

All of which is respectfully submitted [signed] January 2nd, 1830 John B. Morris, Chm. Alex Brown Patrick Macaulay R. B. Magruder F. Lucas Jr.

Upon motion resolved that Messrs Macaulay, Lucas and Magruder be appointed an executive committee in conformity to the foregoing report and that they be vested with. All the duties and power therein proposed.

[Minute Book A, Board of Directors Meetings, 239]

In summary, the special organizational audit committee of directors exonerated Wever, rebuked the Board of

Engineers, repealed its authority, and also set in motion the steps for its dissolution. McNeill offered to resign, which the Board

of Directors did not accept, but he and Long left the B&O within a few months anyway. Wever remained at the B&O for years.

However, McNeill and Long, in an attempt to justify their actions, issued a four hundred-page report entitled:

Narrative of the Proceedings of the Board of Engineers of the Baltimore and Ohio Rail Road Company From Its Dissolution, Together With An Exposition of Facts Illustrative of the Conduct of Sundry Individuals.

By May 1830, part of the crisis abated as 13 miles of track were opened for excursions. Employing a variety of power

sources, wagon–type trains ferried excited citizens on novel rides. The company shifted its focus back to completing a rail-road

connection between Baltimore and the Ohio River.

V. Reorganization

20

The financial crisis and the internal conflict between the Superintendent of Construction and the BOE led the audit

committee to propose an organizational restructuring. In its February 8th, 1830 report, the committee looked at the operations and

the organization and decided a streamlining of duties, responsibilities, and reporting authority was important. This operations

report is included in Exhibit 13; it reviews the cash receipts and payments made to date.

As a result of this audit committee’s work the Board of Directors made major changes to the management structure.

Exhibit 14 contains the key officers designated in this reorganization. Noteworthy is the appointment of a high-ranking staff

auditor whose duties initially focused upon construction contracts was one of the changes. The auditor’s role with regard to

payments of contractors and the treasurer’s job are specified here as well. Given the problems that the B&O had just encountered,

this reorganization was a significant change. Arrangements with contractors and controlling of construction costs were essential

to the railroad’s survival, for it had to reach the Ohio. The staff auditor’s role would be a vital one in accomplishing these plans.

The title “auditor” for this position is somewhat misleading from a 21st Century vantage; the auditor’s duties at the

B&O would be the responsibilities today of a controller [Previts 2000, 24]. Interestingly, when the revenue operations started to

become important, the auditor’s job evolved into having direct line authority by becoming the “Auditor & Superintendent of

Transportation”, and then a couple of years later, the “Superintendent of Transportation” who ran the operations of the trains

[Previts 2000, 24]. William Woodville was the person who was appointed “Auditor” in 1830 and who became the major

operating officer of the company, ranking second only to the President in authority.

Exhibit 13

The report of the Committee appointed in the month of October last to examine into the operations of the company for the last year etc & which was referred from the last meeting of the Board to this, being now read and considered was approved and the regulations therein proposed were adopted, to whit:

The Board of Directors on the 5th of October last appointed a committee “to examine into the operations of

the Company for the last year- To revise and inspect the various expenditures which have been made & the manner in which the work has been executed, and report thereon when prepared”. They were also desired to report in their opinion whether under the experience acquired any improvement can be made in the organization of the Company or in the administration of it affairs. The undersigned therein recognized as a committee have endeavored to execute the duties delegated to them & do a report on so much of the resolution as relates to revision & inspection of the various expenditures of the Company not only for the last year but since the commencement of the work by a particular account furnished by the Treasurer which accompanies [sic] this report & designed to be considered as a part thereof it will appear that $20 per Share has been paid on 40,000 = $800,000.00

That there has been received on a/c of forfeited stock 35.37

Showing the sum total of receipts as per folio 19 [paper D] 800,035.37 And that there has been expended by Commissioners different Deputations & Missions to England as per Folio 19 of paper D) the sum of

$9,830.83

Expenditures on the 4th of July at the commencement of the road as per fo. 2 243.37

For advertising as per folio 3 (paper D) 554.12 For Salaries per folio 4 do 18,203.77 For office expenses folio 5 1,459.91 For stationary as per folio 6 710.44 For Lawyers fees as per folio 7 5,800.00 For Printing as per folio 8 738.15 For Instruments 1,670.37

21

For Postage 420.72 For Surveys 21,616.30 For Right of way & expenses incident thereto fo 12 2,865.33 For Construction of road as per folio 13 649,622.11 For Materials of construction & expense incurred in Laying down rails as per folio 14 & 15 48,732.86For Discounts as per folio 16 6,389.96For Wagons as per folio 17 4,288.96 Carried forward 773,147.20 Amount paid brought over $800,035.37 Amount expended brought over $773,147.20That there is in Bank 16,103.48That due by Lt. Cook 203.89 That due by Col. Long 435.08 That due by L. N. Brown 54.54 That due by Supt of construction 9,427.35 $800,136.97The committee has not thought it was within their province to examine whether the foregoing expenditure has been satisfactorily

accounted for. That duty having been regularly performed by an appropriate Committee, who it is believed have from the Commencement of the enterprise (with the exception of cash) made their quarterly examinations and reported the same to the Board – These reports regularly recorded among the minutes – The Committee referred to the Board – The Committee in the examination of the disbursements have contented themselves with the accompanying analysis of the expenses showing under distinct heads the amount that has been expended in the several branches of the work so that the Board may at a glance learn the amount expended under each appropriate head – by which it is apparent that a considerable sum has been expended on objects other than that portion of the road under contract etc & for which the residue of the road is fairly chargeable with its proportionate share—It is the opinion of the Committee that the operations of the Company may be improved among the material objections to the system under which the affairs have been conducted it may be sufficient to instance one wherein the authority was vested in another body to appoint officers and agents without reference to the Board of Directors or any admission on their part than that which was derived from an examination of the accounts; and as this duty was entrusted to a committee, it is not to be supposed that the Board could be specially informed on the several facts which it is material [emphasis added] for them to be particularly apprised – On a former occasion the Committee recommended a repeal of the existing system & by its adoption the officers in the service were of necessity dispensed with by the management for a time entrusted to a provisional committee whose duty it was to cooperate with the President. In the further execution of this portion of the duty assigned to the Committee they have prepared a system for the government of the Company and now submit the same – So much of the resolution of the 5th of October which directed an enquiry into the manner in which the work has been executed remains yet to be complied with, should the Board still deem such an examination to be necessary on the part of this Committee, it is believed that the wishes of the Board would be promoted by that branch of duty being deferred to a season of the year more favorable than the present for a minute examination. By order 8th February 1830 J. B. Morris, Chair n [Minute Book A, Board of Directors Meetings, 283 & 284]

Exhibit 14

ORGANIZATION OF THE OFFICERS OF THE BALTIMORE & OHIO RAIL ROAD COMPANY There shall be appointed: 1st. A Chief Engineer. Who shall have a general superintendance of direction over all the works of this

Company… 2nd A Superintendent of Construction. Whose duty it shall be to superintend the graduation,

Masonry, Viaducts & Bridges according to the plans to be furnished by him and the instructions he may receive and which plans shall be submitted to be approved by the President & Directors and Chief

Balance due E. T. Griswold as per his a/c Jany 1830 10.23 Balance due A. Barnum as per his a/c Jany 1830 91.37 = 101.60 $800,035.37

22

Engineer. He shall form Estimates of the cost thereof and report the same to the President & Directors. He shall advertise for contracts & shall submit to the President.

3rd An Auditor Whose duty it shall be to keep the Books of the Company, to examine & certify to all

claims or accounts against the Company and to perform such other duties as the President may require of him.

4th A Treasurer Who shall take charge of all Monies belonging to the Company and shall only pay the same

upon regular vouchers to be furnished by the Chief of the department under which the claim arises, after the same shall have been regularly passed by the Auditor, except as regards contingent expenses which shall be paid only upon the certificate of the President passed by the Auditor, or on the vote of the President and Directors. It shall be the duty of the officer at the head of each department to report on the last week of every month to the President of the Company a list of the assistant in his service. The particular duty in which they are employed, the amount of salary they receive, and every three months make a report of the work about to be undertaken, the progress of the work on hand, and the work finished within the preceding three months – On motion resolved that the salary of the Chief Engineer be three thousand dollars per annum-

Resolved that the salary of the Superintendent of Construction be Twenty five hundred dollars per annum

The Board having proceeded to an Election of Officers it appeared that Jonathan Knight was appointed Chief Engineer, Caspar W. Wever Superintendent of Construction and George Brown, Treasurer of the Company. The foregoing salaries to take effect from the 1st of January 1830.

A claim for services rendered by Lieut. Dillahunty certified by Captain McNeill amounted to $393. Was submitted and ordered to be paid. Adjourned.

[Minute Book A, Board of Directors Meetings, 292]

In Table 3, the special “operational” audits by committees of B&O director are summarized. The activities of these

committees varied as the need arose. The reports of these committees indicate activities ranged from examining the construction

vouchers and expenditure records to considering organizational structure and lines of authority issues. The work of these

committees can not be underestimated in importance to the survivability of the B&O and to it ultimately reaching its goal of the

Ohio River and the company’s future prosperity.

TABLE 3 SUMMARY OF SPECIAL AUDITS

Report Date Content/Scope of Report Exhibit # Committee Members April 27, 1829

Examination of Superintendent of Construction’s Accounts

10

Patrick Macaulay, John B. Morris, & William Stewart

December 22, 1829

Examination of Superintendent of Construction’s Accounts

11

John B. Morris, Alexander Brown, Patrick Macaulay, R.B. Magruder, & F. Lucas, Jr.

January 2, 1830

Improvement in Organization

12

John B. Morris, Alexander Brown, Patrick Macaulay, R.B. Magruder, & F. Lucas, Jr.

February 8, 1830

Examination of Construction Expenditures

13

John B. Morris, chairman

23

VI. Summary and Conclusions

This paper provides a summary of auditing procedures used to control the financial, operating and administrative

activities of the Baltimore and Ohio Railroad as utilized during its formative period over 175 years ago. From inception an audit

committee of two or three corporate directors reported to the board each quarter on a review of the treasurer’s account, including

cash balance and disbursements. A second type of audit committee function, employed two years after the formation of the B&O

conducted special operational audits, examining and resolving organizational, personnel and control problems. These

committees represented a corporate governance device of the board of directors who represented shareholders. Asserting power

over independent-minded engineers and managers did not prove to be easy, and audit committees sought to clarify and improve

processes when charged to review the construction contracting problem.

While this research has identified the earliest corporate U.S. railroad use of the audit function by decades, it remains to

be determined when and where the institution of corporate auditing originated. Indeed, the B&O’s establishment of this

committee as a by-law requirement at the commencement of business supports speculation that earlier uses exist, in the US and

elsewhere. However, no earlier systemic use in the U.S. of corporate audit committees has come to our attention. The

discovery described in this paper points out that the B&O Railroad from it commencement employed an audit function conducted

by an audit committee of directors to review the routine accounting records and to control the financial assets. The committee

referred to its work as an “audit”. Further, the audit report rendered to the board of directors attested to the numerical validity of

the information and also referred to it as being “in conformity”. Throughout the audit reports, exceptions were noted and

suggestions for improvements were made. Several special audits addressed operational and organizational issues. Audits of the

Superintendent of Construction and the construction contracts led to recommendations for organizational changes that

strengthened lines of authority and emphasized internal control by specified duties and employment of an auditor to work in

conjunction with the treasurer. A high-ranking staff auditor (controller) also would be an important “internal control”

recommendation by the audit committee to ensure contract expenditures were correct.

The corporate audit committee appears to have influenced the direction and served to control activities of the B&O.

Further it served as the auditor of company financial transactions, verifying the presence of assets and the control and

accountability of disbursements. The audit committee’s work was important as validation for external investors. It served not

only as a safeguard of assets, but it also substantiated management’s presentation of the financial performance and condition of

the railroad. This certainly made investors more willing to advance capital to the company. Finally, the audit committee made

both operational and organizational change recommendations which promoted and assured accountability among those charged

with planning the railroads activities and implementing them. These outcomes suggest conformity of purpose to those objectives

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identified at the outset of this paper, relating to the definition and purposes of such an activity as provided by the OECD and the

NYSE Blue Ribbon Committee.

Our archival investigation into the original minutes and documents identified how larger enterprises developed

governance processes to in order to sustain the confidence of investor who’s property rights and relatedly, information rights

were involved. The officials of the B&O as a corporation established the audit function to assure accountability and recognition

of property rights under the American system, and it advanced the recognition of the right of capital providers to information

about the property invested in a corporate legal entity created by the State to serve the public interest. Further archival work in

early railroad and industrial firms in the 19th century which seek to relate governance, property rights and information rights may

benefit from reflection, over time, on the issues posed by Alchian [1965] and three specific [amended] questions addressed by

Alchian and Demsetz in their 1973 paper, “The Property Right Paradigm” [p. 17]:

1. What is the structure of property rights [information rights] in a society at some point of time?

2. What consequences for social interaction flow from a particular structure of property rights [information rights]?

3. How has this property right [information right] come into being?

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