State v. Southern Bell Tel. & Tel. Co., 3 Div. 940

• Decision Date: 20 December 1962
• Docket Number: 3 Div. 940
• Citation: 274 Ala. 288,148 So.2d 229
• Parties: , 47 P.U.R.3d 65 STATE of Alabama et al. v. SOUTHERN BELL TELEPHONE AND TELEGRAPH COMPANY.
• Court: Alabama Supreme Court

Page 229

148 So.2d 229

274 Ala. 288, 47 P.U.R.3d 65

STATE of Alabama et al. v. SOUTHERN BELL TELEPHONE AND TELEGRAPH COMPANY.

3 Div. 940.

Supreme Court of Alabama.

Dec. 20, 1962.

MacDonald Gallion, Atty. Gen., J. Taylor Hardin, Asst. Atty. Gen., Maurice F. Bishop, Sp. Asst. Atty. Gen., J. Douglas Harris, Atty., Public Service Comm., J. M. Breckenridge, Birmingham, J. Howard McEniry, Bessemer, and Frank B. Parsons, Fairfield, for appellants.

R. E. Steiner, III, Steiner, Crum & Baker, Montgomery, Jas. A. Simpson, Lange, Simpson, Robinson & Somerville, Birmingham, and Walter R. Byars, Gen. Atty., Birmingham, Jefferson Davis, Gen. Counsel of Southern Tel. Co. and Drury B. Thompson, Atlanta, Ga., for appellee.

HARWOOD, Justice.

We are here confronted with litigation that has dragged its way through the processes of the Alabama Public Service Commission, the Circuit Court of Montgomery County, and the Supreme Court of Alabama for over eight years.

The interests of the rate payers, of the Southern Bell Telephone Company, and of the State of Alabama demand that this litigation be concluded. As observed by the trial court in its decree: 'Thus for over six years since the Company filed its application for increased rates, this matter is still unsettled and in litigation. The public does not know that rates it has paid for telephone service over the past six years, nor indeed the price it is now paying. The utility does not know what earnings can be depended upon for the past six years on its operations in Alabama, during which time substantial expansion of its plant and facilities has been undertaken, nor does it yet know what return on its investment in Alabama might be expected from its present business or for its future plans.'

Section 52, Title 48, Code of Alabama 1940, pertaining to the fixing of rates of public utilities by the Public Service Commission provides:

'Rates and charges shall be just and reasonable as to utility and public.--The rates and charges for the services rendered and required shall be reasonable and just to both the utility and the public. Every utility shall be entitled to such just and reasonable rates as will enable it at all times to fully perform its duties to the public and will, under honest, efficient and economical management, earn a fair net return on the reasonable value of its property devoted to the public service. In any determination of the commission as to what constitutes such a fair return, the commission shall give due consideration, among other things, to the requirements of the business with respect to the utility under consideration, and the necessity, under honest, efficient and economical management of such utility, of enlarging plans, facilities and equipment of the utility under consideration, in order to provide that portion of the public served thereby with adequate service.'

Adding some substance in a highly general way to the above provision, Section 319 of Title 48, Code of Alabama 1940, in determining the valuation of the property of a utility, the Commission 'shall give due consideration to the history and development of the utility and its property, original cost, cost of reproduction, as a going concern, and other elements of value recognized by the laws of the land for rate-making purposes.'

As we interpret the above statutes, their effect is to have our Public Service Commission determine utility rates under the theory of a fair rate of return based upon a fair and adequate rate base, as distinguished from the so-called 'cost of capital' theory for determining the rate of return.

The 'cost of capital' theory treats capital charges as a cost of furnishing the public utility service and includes an allowance on debt capital plus any additional return considered necessary to attract investment to the enterprise. The fair rate of return is therefor the composite of an interest rate for debt capital, a figure arrived at without difficulty, and an earning rate for equity capital sufficient to create a fair rate of return when considered together with the cost of debt capital. See The Bell Telephone System Rate Cases, 37 V.L.R. 699.

Under the rate base theory of determining a fair rate of return, the rate base is the valuation placed on the utility property.

Prior to World War II most of the cases dealing with utility rates were concerned with methods of valuation. The 'cost of capital' theory tended to shove this question into the background, though inherent in both theories was the problem of a proper debt-equity ratio in the capital structure of the company.

As before stated, the cost of debt capital usually presents little difficulty, being historical, or at least within probable range of calculation if for the future.

The cost of equity capital is the amount of earnings that should reasonably result from the funds represented by common stock. Unlike bonds, common stock does not contractually provide for the payment of a specific rate of return, and dividends may or may not be paid. This risk element naturally calls for a higher contemplated rate of return by the investor on the equity capital (common stock).

The less the amount of debt in the debt-capital structure, the larger the amount that must be allowed to insure a fair rate of return.

The ideal capital structure would allow a debt-equity ratio in amounts that the company would get its full benefit in the amount of debt capital, and yet not have the debt component so high as to discourage prudent investors. This ideal capital structure is not static. However, many commissions and courts for rate making purposes, have concluded that a debt-equity ratio of 45% debt-55% equity most nearly approximates a proper debt-equity ratio.

In Southern Bell Telephone and Telegraph Co. v. Louisiana Public Service Commission, 239 La. 175, 118 So.2d 372, that court observed:

'Since the decision of the United States Supreme Court in the case of Federal Power Commission v. Hope Natural Gas Co., supra, the hypothetical 45% debt ratio rule has been almost universally adopted in those states where there is no formula prescribed by constitutional provisions or statutes for the determination of a rate base. In addition to the approval of this formula by us it has been held valid by the courts in the states of Massachusetts, ¹ New Hampshire, ² Vermont, ³ Maryland, ⁴ Mississippi, ⁵ New Mexico, ⁶ Idaho, ⁷ and Pennsylvania. ⁸ It has likewise been adopted by the commissions in the States of Tennessee, ⁹ Connecticut, ¹⁰ South Dakota, ¹¹ Utah, ¹² Texas, ¹³ Nebraska, ¹⁴ Illinois, ¹⁵ Alabama, ¹⁶ and in the District of Columbia ¹⁷.'

In the order of the Commission now before us, the rate base has been determined, and the Commission has used a debt-equity ratio of 35-65, as contended for by the Company. In doing so the Commission departed from its findings and order of 1954 considered on the first appeal of this case (Alabama Public Service Commission v. Southern Bell Telephone & Telegraph Co., 253 Ala. 1, 42 So.2d 655). The Commission in its first order in 1954, adopted, among other factors, a debt-equity ratio of 45-55, and a 'net investment rate base.' In its orders now under review, the Commission in addition to changing the debt-equity ratio component from 45-55 to 35-65, adopted a 'reasonable value rate base,' the latter base concededly being more favorable to the Company than the former 'net investment rate base.'

As before stated, the rate base as determined by the Commission was confirmed by the lower court, and is not an issue in this appeal except in the aspect as to return on equity capital. We adverted to this matter in order to dispel any conclusion that this court has by its opinion in the first appeal in this case (253 Ala. 1, 42 So.2d 655), laid down as a mathematical requirement that the debt-ratio of 35-65 must under all circumstances be adhered to. While the question of debt-equity ratio is one for management, its impact substantially affects the manner and cost of obtaining capital, and is therefore an important factor in the rate of return. The fixing of a fair rate of return is exclusively within the jurisdiction of the legislature, or its agency, the Public Service Commission. This court's province is only to determine whether the rate of return fixed by the Commission is within the statutory requirement of being fair to the Company. As aptly stated by the Supreme Court of Massachusetts in New England Telephone & Telegraph Co. v. Dept. of Public Utilities, 331 Mass. 604, 121 N.E.2d 896, 6 P.U.R.3d 65 (1954):

'As a matter of internal management, the company's directors had the right to determine upon the reduction in indebtedness. Indeed, the department's very decision declares that the primary duty of the directors was to exercise their own best judgment of what was best for the company, and intimates by indirection that they did so. The directors did not have to addicate their own business judgment and to ingest the department's opinion or else be denounced as contumacious. But * * * debt structure and the percentages of debt and equity capital enter vitally into the determination of the amount which the consuming public should pay. A 35% debt ratio might be deemed in the nature of a company luxury not to be reflected in rates to be charged the public. In any event, the department could think so without our being able to adjudge that there is anything unlawful or confiscatory about its position.'

We have examined the 80 odd citations of cases and commission order set forth in an appendix to the Company's brief showing rates of return on equity capital. In all but two instances where the debt-equity ratio was commented upon, the courts and commissions used a debt-ratio in excess of the 'historical debt-equity ratio' of 1/3-2/3 which the Company contends is now its right.

We have written to this element of capitalization in determining the base rate since it will of necessity be...