U.S. v. F.C.C.

• Decision Date: 13 May 1983
• Docket Number: No. 81-1751,81-1751
• Parties: UNITED STATES of America, Petitioner, v. FEDERAL COMMUNICATIONS COMMISSION, Respondent, American Telephone and Telegraph Company, United States Independent Telephone Association, Southern Pacific Communications Company, People's Counsel of Maryland, Intervenors.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 610

707 F.2d 610

227 U.S.App.D.C. 413

UNITED STATES of America, Petitioner, v. FEDERAL COMMUNICATIONS COMMISSION, Respondent,

American Telephone and Telegraph Company, United States

Independent Telephone Association, Southern

Pacific Communications Company, People's

Counsel of Maryland, Intervenors.

No. 81-1751.

United States Court of Appeals, District of Columbia Circuit.

Argued May 5, 1982.

Decided May 13, 1983.

Petition for Review of an order of the Federal Communications commission.

Marion L. Jetton, Atty., U.S. Dept. of Justice, Washington, D.C., with whom Barry Grossman and Robert B. Nicholson, Attys., U.S. Dept. of Justice, Washington, D.C., were on the brief, for petitioner.

John E. Ingle, Deputy Associate Gen. Counsel, F.C.C., Washington, D.C., with whom Stephen A. Sharp, Gen. Counsel, Daniel M. Armstrong, Associate Gen. Counsel, and Lisa B. Margolis, Counsel, F.C.C., Washington, D.C., were on the brief, for respondent.

Jules M. Perlberg, Chicago, Ill., with whom David J. Lewis, Alfred A. Green, New York City, and Robert B. Kunkel, Philadelphia, Pa., were on the brief, for intervenor, American Tel. and Tel. Co.

Thomas J. O'Reilly, Daniel J. Greenwald, III, and Shelley S. Sternad, Washington, D.C., were on the brief, for intervenor, U.S. Independent Telephone Ass'n.

Sandra Minch Hodes, Columbia, Md., entered an appearance for intervenor, Office of People's Counsel of Md.

Daniel A. Huber, Washington, D.C., entered an appearance for intervenor, Southern Pacific Communications Co.

Before MacKINNON and WILKEY, Circuit Judges, and HAROLD H. GREENE, ^* United States District Judge for the District of Columbia.

Opinion for the Court filed by District Judge HAROLD H. GREENE.

HAROLD H. GREENE, District Judge:

In this petition for review of an order ¹ of the Federal Communications Commission, the United States ² challenges the rate of return set by the Commission for the interstate and foreign operations of the American Telephone and Telegraph Company.

In March 1979, AT & T, on its own behalf and on behalf of the Bell operating companies, filed with the Commission a petition requesting modification of the then authorized 9.5 percent rate of return. In re AT & T, 57 F.C.C.2d 960, 973 (1976). On May 7, 1981, following extensive proceedings, the Commission issued an order which fixed AT & T's overall rate of return at 12.75 percent. It is that order and that rate of return which are challenged in the instant proceeding. Specifically, the United States questions the methodology by which the Commission arrived at one of the elements it used in calculating the rate of return--the cost of the company's common equity. The Court concludes that the Commission's rationale is both discernible and reasonable, and it therefore affirms the agency's order.

I

The basic principles governing this type of case are well established. Regulated utilities are entitled to earn enough revenue not only to cover operating expenses but also to pay for the capital costs of doing business, including service on debt and dividends on stock. The return to the equity owner must be "sufficient to assure confidence in the financial integrity of the enterprise," Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591, 603, 64 S.Ct. 281, 288, 88 L.Ed. 333 (1944), in order that its credit may be maintained and capital may continue to be attracted. ³ The return should not be higher than necessary for this purpose, however, because otherwise ratepayers would pay the excessive prices that regulation is intended to prevent. ⁴ Permian Basin Area Rate Cases, 390 U.S. 747, 791-92, 88 S.Ct. 1344, 1372-1373, 20 L.Ed.2d 312 (1968); In re AT & T, supra, 9 F.C.C.2d at 52; 47 U.S.C. Secs. 201(b), 205(a). ⁵ Within this general framework, the Commission has broad discretion in selecting the appropriate methodology for calculating the rate of return. FPC v. Hope Natural Gas Co., supra, 320 U.S. at 602, 64 S.Ct. at 287; Aeronautical Radio, Inc. v. FCC, 642 F.2d 1221, 1228 (D.C.Cir.1980), cert. denied, 451 U.S. 920, 976, 101 S.Ct. 1998, 2059, 68 L.Ed.2d 311, 357 (1981).

The FCC employs a "weighted cost of capital" approach in calculating rates of return for carriers subject to its jurisdiction. American Telephone & Telegraph Co., 86 F.C.C.2d 221, 224 (1981). The rate is a composite of the return on the two major components of the company's capital--debt and stockholders' equity, Nader v. FCC, 520 F.2d 182, 191 (D.C.Cir.1975), the elements of the calculation being the cost of debt, the cost of equity, and the proportion of each in the company's capital structure. ⁶

AT & T's rate of return had last been set in 1976 at 9.5 to 10 percent, with the cost of equity being 12 percent. AT & T, 57 F.C.C.2d 960, 971-73 (1976). In March 1979, the company requested a change in the rate, citing alterations in economic conditions. In response to the petition, the Commission directed that an evidentiary hearing be held before an Administrative Law Judge. Order Instituting Hearing, 73 F.C.C.2d 689, 690 (1979). A number of witnesses were heard over a five-month period, and all the parties which actively participated in the hearing, including the United States, agreed that some increase in the rate of return was warranted.

In February 1981, the ALJ concluded that 10.87 percent constituted the appropriate rate of return for AT & T, the cost of the common stock equity component being 14.6 percent. Initial Decision, 86 F.C.C.2d 257, 281-82 (1981). Several parties, including AT & T and the United States, appealed to the full Commission. In its appeal AT & T claimed that its cost of capital had continued to rise while the proceedings were pending, ⁷ and that a market return on equity of 17.2 to 19.4 percent, ⁸ a book return of at least 17 percent, and an overall return of at least 13 percent were required under then current conditions. The Commission's trial staff agreed that the ALJ's recommendation was too low, and it suggested an overall rate of return of 11.5 percent. ⁹

In its May 1981 decision, the Commission likewise indicated its agreement with the proposition that the figure recommended by the ALJ was too low. The Commission explained that the ALJ's calculations failed to take account of the higher price of more recent AT & T bond offerings and other indications that the cost of capital had risen since the initial record was compiled. ¹⁰ The Commission concluded that the cost of common equity under then current conditions was 17.4 percent, and that on this basis an overall rate of return of 12.75 percent was warranted. 86 F.C.C.2d at 251. The basic issue before the Court is whether the Commission adequately explained the methodology it employed to arrive at the new common equity figure. ¹¹

II

The Commission began with the undisputed premise that the cost of AT & T's equity will exceed the cost of its long-term debt. ¹² See Nader v. FCC, supra, 520 F.2d at 241, 246. See also Comsat v. FCC, 611 F.2d 883, 899, 901-02 (D.C.Cir.1977). Next, the Commission attempted to determine the cost of the current long-term debt, and then the figure that, when added to that cost, would account for the greater risk associated with an equity investment. ¹³

The most recent available information concerning the cost of AT & T's long-term debt was provided by a New Jersey Bell bond offering at 14.9 percent and a Pacific Telephone and Telegraph offering at 16.4 percent. In the exercise of its discretion the Commission chose the lower of the two figures as its reference point, a decision which is not here challenged. However, the United States does challenge the Commission's method of arriving at the increment by which the cost of AT & T's common stock equity should properly exceed the cost of the company's long-term debt. ¹⁴

Several expert witnesses had assessed the cost of common equity before the ALJ, principal among them Virginia Dwyer, vice president and treasurer of AT & T, Irwin Friend, another AT & T witness; and Mark Langsam, an expert called by the United States. Ms. Dwyer concluded on the basis of her computations ¹⁵ that AT & T's book cost of common equity was in the range of 16.4 to 17.6 percent. 86 F.C.C.2d at 237. Dr. Friend testified that the cost of AT & T's equity was 16 percent; ¹⁶ and Mr. Langsam concluded that the proper return on AT & T's common stock equity would be in the range of 12.5 to 13.5 percent. The FCC criticized aspects of the testimony of each of these witnesses, but ultimately relying upon a synthesis of these expert opinions, it found that AT & T's cost of common equity was 17.4 percent.

The Commission concluded that Ms. Dwyer's assessment of an equity risk premium amounting to 5.6 to 6.6 percent overstated the difference in risk between AT & T's bonds and AT & T's stock, referring specifically to the fact that the witness had compared industrial bonds with industrial stock without demonstrating that AT & T's stock carried the same risk as the industrial stocks in her sample. ¹⁷ However, in the Commission's opinion, Mr. Langsam's analysis compensated for this flaw since his "comparable earnings" approach sought to measure the very variable absent from Ms. Dwyer's analysis: the risk of AT & T stock compared with the risk of the stock of a composite of industrial corporations. On the basis of this testimony, the Commission was able to adjust downward Ms. Dwyer's risk premium to arrive at a risk premium tailored to AT & T. See infra. The ultimate 17.4 percent figure accepted by the Commission is composed of the cost of long term debt (14.9 percent) plus a risk factor amounting to 2.5 percent. ¹⁸ It is this computation that the government challenges.

The United States argues that the Commission's decision represents a failure of reasoned decision-making in that the agency failed adequately or rationally to explain its choice of 17.4 percent as AT & T's cost of equity. See Bowman Transportation Inc. v. Arkansas-Best Freight Systems,...