Filed 6/18/19; pub. order 6/28/19 (see end of opn.)

IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

FIFTH APPELLATE DISTRICT

THE PONDEROSA TELEPHONE CO., et al.,

Petitioners,

v.

CALIFORNIA PUBLIC UTILITIES 

COMMISSION,

Respondent.

F076845

(CPUC Decision Nos. 16-12-035 &

17-12-029)

OPINION

ORIGINAL PROCEEDINGS; petition for writ of review.

Cooper, White & Cooper, Mark P. Schreiber, Patrick M. Rosvall, Sarah J. Banola, 

and Priya D. Brandes, for Petitioners.

Arocles Aguilar, Helen W. Yee, and Eleanor M.W. Youngsmith for Respondent.

-ooOooIn this original proceeding, three rural telephone companies, The Ponderosa 

Telephone Co., Sierra Telephone Company, Inc,. and Volcano Telephone Company

(together petitioners), challenge the decision of the California Public Utilities 

Commission (PUC) establishing petitioners’ “cost of capital,” which is a financial 

yardstick used by the PUC as a component in ratemaking.1 Conceptually, a utility 

 

1

In decision No. 16-12-035 entitled “Decision Determining the Cost of Capital for 

Ratemaking Purposes for California’s Independent Small Telephone Companies,” the 

PUC determined petitioners’ cost of capital (PUC decision). In decision No. 17-12-029, 

the PUC denied a request for rehearing. Petitioners challenge both decisions.
2.

company’s cost of capital, also referred to as a rate of return, reflects that company’s cost 

of generating or obtaining capital for investment in assets (e.g., facilities, equipment or 

infrastructure) that provide utility services to customers.2 Petitioners contend the PUC 

failed to adequately consider certain risks that exist for investing in small, rural telephone 

companies, and therefore the cost of capital was set at an unreasonably low level, 

resulting in a confiscatory rate of return. Based on this line of argument, petitioners 

claim the PUC decision should be annulled as allegedly (i) contrary to constitutional 

principles that require a reasonable rate of return, and (ii) lacking in substantial evidence 

or otherwise arbitrary and capricious. The PUC responds that its determination of 

petitioners’ cost of capital was a reasonable decision based on a fair consideration of all 

the evidence and argument, noting further that it was not required to adopt the 

methodology urged by petitioners. Also, the PUC points out that some of the purported 

risks are mitigated through revenue subsidies received by petitioners as small rural 

telephone companies. 

On balance, we conclude petitioners have failed to meet their burden of 

demonstrating that the PUC’s cost of capital determination was arbitrary, capricious, 

lacking in any evidentiary support, or that it otherwise fell short of constitutional 

standards regarding a reasonable rate of return. Accordingly, the PUC’s decision 

Nos. 16-12-035 and 17-12-029 are hereby affirmed. 

FACTS AND PROCEDURAL HISTORY

The Parties

Petitioners are small, rural, independent, privately-owned telephone companies, 

also known as Incumbent Local Exchange Carriers (sometimes referred to in the record 

as LEC’s or ILEC’s). These companies offer basic local telephone service to customers 

 

2 See, The Ponderosa Telephone Co. v. Public Utilities Com. (2011) 

197 Cal.App.4th 48, 51-52 (Ponderosa).
3.

in rural and remote areas of California, are considered carriers of last resort within their 

service areas, and are each regulated by the PUC under a traditional “rate of return” 

regulatory structure. Additionally, pursuant to Public Utilities Code3section 275.6, 

petitioners receive supplemental ratepayer funding through the California High-Cost 

Fund-A Administrative Committee Fund Program (CHCF-A program). (§ 275.6, 

subds. (a) & (d).) Because the cost of providing service in rural and remote areas is high 

compared to the rates permitted to be charged to rural customers, eligible telephone 

companies receive CHCF-A subsidies. The CHCF-A program is funded by surcharges 

assessed against all California telephone customers. (Ponderosa, supra, 197 Cal.App.4th 

at p. 52.) 

The PUC, respondent herein, is the state agency charged with regulating public 

utilities pursuant to article XII of the California Constitution and the Public Utilities Act 

(§ 201 et seq.). (Clean Energy Fuels Corp. v. Public Utilities Com. (2014) 

227 Cal.App.4th 641, 648 (Clean Energy).) Statutorily, the PUC is authorized to 

supervise and regulate public utilities and to “ ‘do all things ... which are necessary and 

convenient in the exercise of such power and jurisdiction’ (§ 701); this includes the 

authority to determine and fix ‘just, reasonable [and] sufficient rates’ (§ 728) to be 

charged by the utilities.” (Southern California Edison Co. v. Peevey (2003) 31 Cal.4th 

781, 792.) Its power to fix rates and establish rules has been liberally construed. (Ibid.) 

In the proceedings below, the PUC’s Public Advocate’s Office, which was 

formerly known as the Office of Ratepayer Advocates (ORA), intervened as a party and 

opposed petitioners’ proposals for determining cost of capital. ORA is an independent 

office within the PUC that participates in proceedings and is charged with representing 

ratepayer or customer interests in ratemaking proceedings. (§ 309.5.)

 

3 Undesignated statutory references are to the Public Utilities Code.
4.

Introduction to the Cost of Capital 

Before delving into the specifics of the parties’ positions relating to the cost of 

capital determination, and in order to make the financial information and terminology 

more understandable, we believe further elaboration on the concept of the cost of capital 

would be helpful. 

As noted, a utility company’s cost of capital, also known as the rate of return, 

reflects the cost the company must pay to generate capital used for investment in 

infrastructure and equipment. (See, Ponderosa, supra, 197 Cal.App.4th at p. 51; see also, 

§ 275.6, subd. (b)(2), (b)(5) & (c)(2).) The parties’ briefing to this court expressly 

acknowledges this basic understanding of the function of cost of capital. As the PUC 

states in its respondent’s brief, the rate of return should be set “at a level that is adequate 

to enable the utility to attract investors to finance the replacement and expansion of its 

facilities so it can fulfill its public utility service obligation,” which requires “comparing 

market returns on investments for other companies with similar levels of risk.” Similarly, 

petitioners state in their opening brief as follows: “The ‘cost of capital’ is a ratemaking 

component that reflects a utility’s costs of generating capital to invest in utility plant. It 

is also known as the ‘rate of return’ because it defines the target return on the utility’s 

capital that must be used in setting rates. ‘Cost of capital’ is a measurement of the cost of 

obtaining debt and equity financing, and it reflects the amount investors would demand to 

compensate them for the risks of investing capital in the company.” 

The above descriptions of the purpose or function of the cost of capital are 

consistent with the legislative pronouncements in section 275.6, subdivision (c)(2), which 

require the PUC in administering the CHCF-A program to accomplish the following 

objectives: “Employ rate-of-return regulation to determine a small independent 

telephone corporation’s revenue requirement in a manner that provides revenues and 

earnings sufficient to allow the telephone corporation to deliver safe, reliable, highquality voice communication service and fulfill its obligations as a carrier of last resort in 
5.

its service territory, and to afford the telephone corporation a fair opportunity to earn a 

reasonable return on its investments, attract capital for investment on reasonable terms, 

and ensure the financial integrity of the telephone corporation.” The term “revenue 

requirement” in the above provision means “the amount that is necessary for a telephone 

corporation to recover its reasonable expenses and tax liabilities and earn a reasonable 

rate of return on its rate base.” (§ 275.6, subd. (b)(5).) The term “rate base” means “the 

value of a telephone corporation’s plant and equipment that is reasonably necessary to 

provide regulated voice services and access to advanced services, and upon which the 

telephone corporation is entitled to a fair opportunity to earn a reasonable rate of return.” 

(§ 275.6, subd. (b)(2).) 

Having described the function of the cost of capital, the crucial question is how the 

cost of capital is reasonably measured or ascertained. The case of Ponderosa, supra, 

197 Cal.App.4th at pp. 51-52, provides a starting point. We observed in that case there 

are ordinarily three major components or steps in determining the cost of capital: (1) the 

cost of debt, (2) the cost of equity (i.e., the necessary return to generate equity 

investment), and (3) the capital structure. (Id. at pp. 51-52.) The following is our 

summary in that case of the cost of capital and other closely-related concepts: 

“The [PUC] examines several cost components in calculating a utility company’s 

revenue requirement. The [PUC] begins by determining the value of the assets 

that the company has invested in to provide utility service. Property or portions 

thereof that are unproductive for public utility purposes are excluded. This figure 

is known as the ‘rate base.’ [¶] To invest in rate base assets, a utility company 

raises funds by either issuing debt or selling equity. Costs are associated with 

each method. The company either has to pay interest to creditors on borrowed 

funds or pay a portion of profits or dividends to equity investors, i.e., shareholders. 

This cost is known as the cost of capital. The cost of capital, also known as the 

rate of return, multiplied by the rate base is one component of the utility 

company’s revenue requirement. 

Utility companies usually use a mix of debt financing and equity as a source of 

funds for their regulated activities. The reason is that, while debt is cheaper to 

obtain, it increases financial risks to the shareholders. Interest must be paid to 
6.

creditors regardless of how the company is doing financially. On the other hand, 

shareholders expect an annual return that is usually greater than the cost of debt. 

Accordingly, companies attempt to find a middle ground between all-equity 

financing and all-debt financing. 

The [PUC] determines a utility company’s cost of capital in a three-step process. 

The [PUC] first adopts a reasonable capital structure, i.e., the proportion of debt to 

equity that a utility company should use to finance its capital needs. Next the 

[PUC] calculates the company’s cost of debt, based on the actual cost of the 

company’s outstanding debt during the most recent period. Third, the [PUC] 

determines the appropriate return on the equity component of the utility 

company’s capital by examining returns for businesses with comparable risks. 

Applying the resulting figures to the adopted capital structure produces the 

weighted cost of capital. This weighted cost of capital becomes the utility 

company’s authorized rate of return on rate base. Alternatively, the [PUC] may 

simply apply an overall rate of return without regard to a specific capital 

structure.” (Ponderosa, supra, 197 Cal.App.4th at pp. 51-52.)

Here, the contesting parties largely adopted the basic framework outlined above. 

In the proceedings before the PUC, petitioners and ORA agreed that the cost of capital 

formula should include (i) cost of debt, (ii) cost of equity and (iii) a capital structure from 

which to calculate a weighted average cost of capital.4 However, as the PUC decision 

stated, although the parties agreed on this basic initial formula, “[they] disagree[d] as to 

the inputs for each of the companies, and whether any adjustments should be made to 

those inputs.” Not only did petitioners and ORA disagree on the proper measure to use 

for the cost of debt, the cost of equity and the appropriate capital structure, but they also 

fundamentally disagreed whether additional risk factors (or premia) should be applied to 

increase the cost of equity. 

With respect to calculating the cost of equity component, petitioners and ORA 

both used a model known as the Capital Asset Pricing Model (CAPM). Under the CAPM 

 

4 As petitioners accurately summarize: “[A]n accurate cost of capital must 

account for the interest rate applied to debt (the ‘cost of debt’), the return necessary to 

generate equity (the ‘cost of equity’), and the relative proportion of the two upon which 

the utility must rely (the ‘capital structure’). ... A combination of these three factors 

results in the overall cost of capital.” 
7.

model, one first determines the risk-free rate of investment, usually based on a 20-year 

U.S. Treasury Bond over a selected time, to which an equity risk premium (and other risk 

premia if applicable) would be added to reach a total cost of equity. According to the 

PUC decision, the equity risk premium “is the amount of additional return above the riskfree rate that is required to produce a return on equity high enough to attract the necessary 

capital for the operation.” 

According to petitioners’ expert, Michael Balhoff, the equity risk premium “is the 

difference between what a risk-free investment ... would generate and what stocks in the 

market over the same period would produce.” In applying the CAPM model, ORA’s 

position was that to determine the cost of equity for the rural telephone companies, the 

only upward adjustment or premium added to the risk-free rate would be the equity risk 

premium, since that premium would in this case adequately represent “the amount of 

additional return required to produce a return on equity ... high enough to attract the 

necessary capital.” In contrast, petitioners’ view was that after the equity risk premium 

was added to the risk-free rate, several additional risk premia should be applied to 

account for special risk factors such as the small size of the telephone companies, 

industry risk and regulatory risk. As the PUC noted, petitioners’ method, also referred to 

as a “build-up” CAPM method, purported to “break[] out” or itemize each of the material 

risk factors into specific premia that, taken together with the risk-free rate, generate the 

proposed cost of equity. 

It is fair to say that the main controversy between petitioners and ORA in the PUC 

proceedings was whether the cost of equity should be increased, beyond the initial sum of 

the equity risk premium and the risk-free rate, based on the special or additional risk 

factors allegedly applicable to petitioners, including the small size of each telephone 

company and other industry-specific and/or regulatory risks allegedly affecting small 

rural telephone companies such as petitioners. 
8.

As will be seen, the PUC ultimately adopted the two-input approach recommended 

by ORA on the cost of equity, but also used other corroborating information. 

Historical Background – the 1997 Setting of Cost of Capital

Prior to the 2016 issuance of the challenged PUC decision, a 10 percent rate of 

return for small rural telephone companies had been in effect since 1997. In a series of 

1997 PUC cases, the PUC established a “10 percent return on rate base” without regard to 

each company’s actual capital structure at that time. In these cases, the PUC did not 

specify an exact equity rate of return, but analysis showed it would fall within a range of 

reasonableness. We note that, in the present case, petitioners and ORA both agree the 

10 percent rate of return would indicate an implied cost of equity of approximately 

12 percent in the 1997 cases. The 10 percent rate of return or cost of capital set by the 

PUC in 1997 was not assigned through the application of a rigid formula; rather, the PUC 

apparently reached an overall judgment that this rate of return would adequately 

compensate shareholders for their risk and would be fair and reasonable to ratepayers and 

shareholders. (See, e.g., In re Sierra Telephone Co., Inc. (1997) 71 Cal.P.U.C.2d 506; In 

re Foresthill Telephone Co. (1997) 71 Cal.P.U.C.2d 530; In re Calaveras Telephone Co. 

(1997) 71 Cal.P.U.C.2d 552; In re Ducor Telephone Co. (1997) 71 Cal.P.U.C.2d 574; In 

re California-Oregon Telephone Co. (1997) 71 Cal.P.U.C.2d 596.) 

Petitioners’ Application to the PUC

In 2015, the PUC authorized a consolidated proceeding to examine the cost of 

capital for each of ten small telephone companies that were CHCF-A program recipients. 

In September 2015, the ten companies applied to the PUC to determine cost of capital. 

Petitioners herein are three of the original ten applicants.5 

 

5 For convenience, we sometimes refer to the application as petitioners’ 

application, even though there were seven additional applicants.
9.

The application proposed that the PUC should establish the cost of capital for each 

of the applicant telephone companies using a cost of equity of 18.5 percent (based on 

premia for special risks of investment in small rural telephone companies), a hypothetical 

capital structure of 70 percent equity to 30 percent debt, and the actual cost of debt for 

each company. Although the application called for use of the actual cost of debt for each 

company, it was noted that if a cost of debt of 5.5 percent were applied, the applicants’ 

proposal would result in a 14.6 percent weighted average cost of capital for each 

company. This proposal represented a considerable increase from the previous figure of 

10 percent.

The application asserted that although the PUC had been using a 10 percent 

overall rate of return on rate base since 1997, the 10 percent rate of return was no longer 

adequate in light of significantly increased risks of investment in rural telephone 

companies. The application and supporting evidence pointed to several business and 

investment risk factors, including market or competition changes (e.g., wireless 

alternatives), regulatory changes potentially affecting funding derived from federal and 

state support programs, and the small size of the rural telephone companies. Balhoff’s 

written testimony was attached in support of the application, including his financial 

analysis regarding the cost of capital. In particular, Balhoff explained his assessment that 

risk premia should be applied to increase the cost of equity based on such special risk 

factors as company size, industry-specific risk and regulatory risk, among others. The 

risk premia figures Balhoff asserted should be applied in computing the cost of equity 

included a proposed 5.78 percent “size” premium based on risks associated with the 

telephone companies’ small size, as well as an industry-specific risk premium of between 

.30 and .42 percent. In the event a size premium were not approved, Balhoff contended 

at least a 2 percent premium should be added to account for regulatory risk. 
10.

ORA’s Response to Petitioners’ Application

On February 12, 2016, ORA filed objections to the cost of capital proposals in 

petitioners’ application. ORA’s filing was entitled “Report and Recommendation on the 

Cost of Capital for Independent Small Local Exchange Carriers.” ORA asserted the 

requested cost of equity of 18.5 percent was unreasonable and excessive, and ORA also 

disputed the claim that special risk premia should be applied in calculating the cost of 

equity. ORA recommended the PUC use only two inputs under the CAPM model to 

determine cost of equity – i.e., the risk-free rate and the equity risk premium. ORA 

asserted that, under the two inputs for calculating cost of equity, and using estimates 

ORA claimed were reasonable, the cost of equity for each company would be 8.79 

percent. Additionally, ORA proposed the PUC use the actual debt costs and the actual 

capital structure of each telephone company, which would then produce an individualized 

weighted cost of capital for each company. Under ORA’s calculations, the weighted 

costs of capital for each company would range from 6.24 percent to 7.67 percent. 

Finally, ORA asserted the risks alluded to by the small rural telephone companies were 

largely mitigated due to revenues or subsidies received from the state’s CHCF-A program 

and the federal Universal Service Fund (USF). 

In summary, comparing petitioners’ application and ORA’s response, petitioners 

requested a cost of capital determination for each company of approximately 

14.6 percent, while ORA argued the PUC should adopt a much lower cost of capital for 

each company, ranging from 6.24 percent to 7.67 percent. As noted, the major source of 

disagreement was with respect to the cost of equity component.

Other Evidence and Argument in the PUC Proceedings

On March 11, 2016, the small rural telephone companies served Balhoff’s written 

rebuttal testimony responding to ORA’s analysis and critiquing ORA’s evidence. In 

general, Balhoff’s rebuttal testimony asserted ORA’s recommendations were inconsistent 

with prevailing valuation methodologies and failed to properly reflect the actual risks 
11.

facing the small rural telephone companies. Balhoff’s rebuttal testimony reiterated there 

is evidence to support risk premia associated with small company size and industryspecific or regulatory risks, and also argued subsidy programs such as the CHCF-A 

program did not shield the companies from such risks. Further, Balhoff’s rebuttal 

testimony indicated ORA’s use of only two inputs, the risk-free rate and equity risk 

premium, in determining cost of equity was unreasonable because it would mean 

“[i]ndependent Small LEC’s have equity costs that are no different from the equity costs 

in the general market[,]” a proposition that “has never been endorsed by the financial 

community and has never been supported by a regulatory body, to the best of my 

knowledge.” 

On April 7 and 8, 2016, an evidentiary hearing was conducted before an 

administrative law judge in San Francisco. Twenty-three exhibits were received into 

evidence during the evidentiary hearing, and petitioners and ORA each had their expert 

witnesses appear and testify. Balhoff was petitioners’ sole expert, while ORA’s experts 

were its staff members Charlotte Chitadje, Roy Keowen and Patrick Hoglund. 

On May 13, 2016 and June 3, 2016, after all the evidence was received, petitioners 

and ORA filed their respective opening and reply briefs before the PUC. A proposed 

decision was issued by the administrative law judge, and the parties filed their comments 

in response to the proposed decision. 

The PUC Decision

On December 20, 2016, the PUC issued its final decision in 16-12-035, adopting a 

range of costs of capital (i.e., rates of return) for petitioners and the other rural telephone 

companies. The costs of capital established for petitioners were as follows: The 

Ponderosa Telephone Co. – 8.44 percent; Sierra Telephone Company, Inc. –

9.22 percent; and Volcano Telephone Company – 9.12 percent. The PUC calculated 

these costs using a hypothetical capital structure of 70 percent equity to 30 percent debt, a 

10.8 percent cost of equity, and the actual debt costs for each of the companies. 
12.

In computing cost of equity, the PUC adopted ORA’s recommended two input 

methodology (i.e., the risk-free rate and the equity risk premium), and rejected the 

petitioners’ recommended approach of applying additional risk premia to increase the 

cost of equity. In its decision, the PUC defined the equity risk premium as “the amount 

of additional return above the risk-free rate that is required to produce a return on equity 

high enough to attract the necessary capital for the operation.” The PUC explained the 

methodology it adopted as follows: “We agree with ORA that Applicants have failed to 

show that more than two components are justified in this case to calculate a reasonable 

cost of equity. The Commission has traditionally used two inputs to the CAPM, the 

equity risk premium and the risk-free rate, to calculate the cost of equity for a regulated 

utility. We have traditionally held there should be no adjustments to the financial 

modeling results for other financial, business or other regulatory risks because the 

financial modeling results already include those risks. We have not been convinced that

we should deviate from this method in this case.”

The conclusions of law enumerated in the PUC decision included the following 

statements: “1. The legal standard for setting the fair cost of capital has been established 

by the United States Supreme Court in the Bluefield and Hope cases. [¶] 2. This decision 

has considered all reasonable observable factors to develop a full picture of the risks 

facing the Small LECs. [¶] ... [¶ ] 8. The Commission has traditionally used two inputs 

to the [CAPM], the equity risk premium and the risk-free rate, to calculate the cost of 

equity for a regulated utility. [¶] 9. It is the application of informed judgment, not the 

precision of quantitative financial models, which is the key to selecting a specific cost of 

capital. [¶] 10. Company-wide factors such as risks, capital structures, and debt costs 

are considered in arriving at a fair cost of capital. [¶] 11. There should be no 

adjustments to the financial modeling results for other financial, business or other 

regulatory risks because the financial modeling results already include those risks.” 
13.

Denial of Request for Rehearing

On January 19, 2017, petitioners filed an application to the PUC for rehearing of 

the PUC decision, asserting error in several respects. Petitioners claimed the PUC’s 

refusal to recognize the additional risks facing the rural telephone companies resulted in 

an unreasonably low rate of return in violation of constitutional principles. Additionally, 

petitioners argued that, in light of the evidentiary record, the PUC’s decision rejecting 

any risk premia (other than the equity risk premium) was arbitrary and capricious, and 

unsupported by substantial evidence. 

On December 18, 2017, in decision No. 17-12-029, the PUC denied petitioners’ 

request for a rehearing of decision No. 16-12-035. In denying rehearing, the PUC held 

petitioners’ rehearing application failed to show the PUC decision resulted in an 

unconstitutional taking or was the result of arbitrary and capricious decision-making. 

Further, the PUC noted it was entitled to rely on ORA’s evidence and analysis, rather 

than on that of petitioners, and pointed out that petitioners’ analysis and evidence were 

not disregarded but were deemed “not persuasive.” Thus, according to the PUC, the 

rehearing application showed no more than a difference of opinion, rather than legal 

error. For these reasons, the request for rehearing was denied. 

Petitioners’ Petition for Writ of Review

On January 18, 2018, petitioners filed a petition for writ of review to this court, 

challenging the PUC decision regarding cost of capital (16-12-035) and the denial of 

rehearing (17-12-029). The grounds for seeking our review were (i) the PUC allegedly 

violated petitioners’ constitutional rights because, in determining the cost of capital, it 

failed to consider specific and well-documented risks facing petitioners; and (ii) the 

PUC’s conclusions relating to the specific risks facing petitioners were arbitrary and 

capricious, unsupported by substantial evidence in the record, and refuted by compelling 

evidence presented by petitioners. 
14.

On March 13, 2018, based on the petition, briefing and exhibits on file, we ordered 

that a writ of review issue, and informed the parties this court would review PUC 

decision Nos. 16-12-035 and 17-12-029. We ordered the PUC to certify the 

administrative record to this court and informed the parties oral argument would be held 

at a date and time to be announced. 

DISCUSSION

I. Standard of Review

Since the cost-of-capital determination by the PUC was incidental to ratemaking, 

section 1757 governs the scope of our review. Under that section, “the review by the 

court shall not extend further than to determine, on the basis of the entire record ..., 

whether any of the following occurred: [¶] (1) The [PUC] acted without, or in excess of, 

its powers or jurisdiction. [¶] (2) The [PUC] has not proceeded in the manner required by 

law. [¶] (3) The decision of the [PUC] is not supported by the findings. [¶] (4) The 

findings in the decision of the [PUC] are not supported by substantial evidence in light of 

the whole record. [¶] (5) The order or decision of the [PUC] was procured by fraud or 

was an abuse of discretion. [¶] (6) The order or decision of the [PUC] violates any right 

of the petitioner under the Constitution of the United States or the California 

Constitution.” (§ 1757, subd. (a).) 

Because the PUC is not an ordinary administrative agency, but a constitutional 

body with broad legislative and judicial powers, its decisions are presumed valid. 

(Ponderosa, supra, 197 Cal.App.4th at p. 56.) Thus, a party challenging a PUC decision 

has the burden of proving it suffers from prejudicial error. (Pacific Gas & Electric Co. v.

Public Utilities Com. (2015) 237 Cal.App.4th 812, 838 (PG&E).) The presumption of 

correctness of the PUC’s findings has consistently been described by our Supreme Court 

as a “strong” presumption. (City and County of San Francisco v. Public Utilities Com. 

(1985) 39 Cal.3d 523, 530 (San Francisco); Pacific Tel. & Tel. Co. v. Public Util. Com. 

(1965) 62 Cal.2d 634, 647 (PacTel) [“[s]trong presumption of the correctness of the 
15.

findings ... of the commission, which may choose its own criteria or method of arriving 

at its decision, even if irregular, provided unreasonableness is not ‘clearly 

established’ ”].) 

It is for the agency to weigh the preponderance of conflicting evidence, and its 

findings are not open to attack for insufficiency if they are supported by any reasonable 

construction of the evidence. (Clean Energy, supra, 227 Cal.App.4th at p. 649.) Thus, 

the PUC’s factual findings based on conflicting evidence or on undisputed evidence from 

which conflicting inferences may reasonably be drawn are final and not subject to review. 

(San Francisco, supra, 39 Cal.3d at p. 530.)6 In other words, if the PUC’s findings are 

supported by any substantial evidence, they may not be set aside. (Ibid.) Accordingly, 

“[t]o accomplish the overturning of a Commission finding for lacking the support of 

substantial evidence, the challenging party must demonstrate that based on the evidence 

before the Commission, a reasonable person could not reach the same conclusion. 

[Citations.] It is for this reason that the Commission’s factual findings are almost always 

treated as ‘conclusive’ [citation], ‘final and not subject to review.’ ” (PG&E, supra, 

237 Cal.App.4th at p. 839; accord, SFPP, L.P. v. Public Utilities Commission (2013) 

217 Cal.App.4th 784, 794 (SFPP) [courts may reverse agency’s decision only if, based 

on the evidence before the agency, no reasonable person could reach the conclusion it 

did].) 

To the extent a challenged PUC decision involves the interpretation or application 

of the Public Utilities Code or regulations regarding a matter within the agency’s special 

expertise, reviewing courts extend considerable deference to the PUC’s conclusions, and 

ordinarily such a decision will not be disturbed unless it fails to bear a reasonable relation 

 

6 The only exception to this rule is where findings and conclusions are drawn by 

the PUC from undisputed evidence and the evidence is such that conflicting inferences 

may not reasonably be drawn. (PacTel, supra, 62 Cal.2d at p. 647.) In that case, a 

question of law is presented. (Ibid.)
16.

to statutory purposes and language. (PG&E, supra, 237 Cal.App.4th at pp. 839-840.) In 

the end, however, questions of statutory or regulatory construction are legal questions

decided by the courts. (Id. at p. 840.) 

Where a PUC decision is challenged on the ground it violates a constitutional 

right, the reviewing court must exercise independent judgment on the law and the facts, 

and the PUC’s findings or conclusions material to the constitutional question are not 

final. (§ 1760.) Nevertheless, “we may not substitute our own judgment ‘as to the 

weight to be accorded evidence before the Commission or the purely factual findings 

made by it.’” (SFPP, supra, 217 Cal.App.4th at p. 794, citing Goldin v. Public Utilities 

Commission (1979) 23 Cal.3d 638, 653; accord, PG&E, supra, 237 Cal.App.4th at p. 838 

[even where constitutional claims are raised, reweighing of evidence and testimony 

ordinarily not permitted].) 

II. Overview of Constitutional Principles

A series of United States Supreme Court cases declare the basic constitutional 

principles relevant to the rate-of-return or cost of capital determinations in this case, 

including Bluefield Water Works & Improvement Co. v. Public Service Commission of 

West Virginia (1923) 262 U.S. 679 (Bluefield), Federal Power Commission v. Hope

Natural Gas Co. (1944) 320 U.S. 591 (Hope), and Duquesne Light Co. v. Barasch (1989) 

488 U.S. 299 (Duquesne). As the PUC decision itself acknowledges, “[t]he legal 

standard for setting the fair cost of capital has been established by the United States 

Supreme Court in the Bluefield and Hope cases.” We begin by summarizing the 

constitutional principles announced in the above cases. 

In Bluefield, supra, 262 U.S. 679, a utility company contended the rate of return 

set by the state commission in that case was too low and confiscatory. (Id. at p. 692.) In 

explaining the relevant constitutional standard for rate of return determinations, the 

Supreme Court stated as follows: “What ... rate will constitute just compensation 

depends upon many circumstances and must be determined by the exercise of a fair and 
17.

enlightened judgment, having regard to all relevant facts. A public utility is entitled to 

such rates as will permit it to earn a return on the value of the property which it employs 

for the convenience of the public equal to that generally being made at the same time and 

in the same general part of the country on investments in other business undertakings 

which are attended by corresponding risks and uncertainties; but it has no constitutional 

right to profits such as are realized or anticipated in highly profitable enterprises or 

speculative ventures. The return should be reasonably sufficient to assure confidence in 

the financial soundness of the utility and should be adequate, under efficient and 

economical management, to maintain and support its credit and enable it to raise the 

money necessary for the proper discharge of its public duties. A rate of return may be 

reasonable at one time and become too high or too low by changes affecting opportunities 

for investment, the money market and business conditions generally.” (Id. at pp. 692-

693, italics added.) In the same decision, the Supreme Court noted the legal 

consequences of a failure to set a reasonable rate of return: “Rates which are not 

sufficient to yield a reasonable return on the value of the property used at the time it is 

being used to render the service are unjust, unreasonable and confiscatory, and their 

enforcement deprives the public utility company of its property in violation of the 

Fourteenth Amendment.” (Id. at p. 690.)

Similarly, in Hope, supra, 320 U.S. 591, the Supreme Court articulated the 

relevant principles as follows: “[T]he fixing of ‘just and reasonable’ rates, involves a 

balancing of the investor and the consumer interests. Thus we stated in the Natural Gas 

Pipeline Co. case that ‘regulation does not insure that the business shall produce net 

revenues.’ [Citation.] But such considerations aside, the investor interest has a 

legitimate concern with the financial integrity of the company whose rates are being 

regulated. From the investor or company point of view it is important that there be 

enough revenue not only for operating expenses but also for the capital costs of the 

business. ... By that standard the return to the equity owner should be commensurate 
18.

with returns on investments in other enterprises having corresponding risks. That return, 

moreover, should be sufficient to assure confidence in the financial integrity of the 

enterprise, so as to maintain its credit and to attract capital.” (Hope, supra, 320 U.S. at 

p. 603, italics added.) The Hope case concluded that the “fair value” system was not the 

only constitutionally acceptable method of fixing utility rates, explaining as follows: 

“Rates which enable the company to operate successfully, to maintain its financial 

integrity, to attract capital, and to compensate its investors for the risks assumed certainly 

cannot be condemned as invalid, even though they might produce only a meager return 

on the so-called ‘fair value’ rate base.” (Id. at p. 605.) 

More recently, in Duquesne, supra, 488 U.S. 299, the Supreme Court stated the 

guiding principle in rate cases has been “that the Constitution protects utilities from being 

limited to a charge for their property serving the public which is so ‘unjust’ as to be 

confiscatory.” (Id. at p. 307.) Further, the Supreme Court in Duquesne went on to 

reiterate the principle in Hope and Bluefield that “[o]ne of the elements always relevant to 

setting the rate under Hope is the return investors expect given the risk of the enterprise. 

[Hope, supra, 320 U.S.] at p. 603 (‘[R]eturn to the equity owner should be commensurate 

with returns on investments in other enterprises having corresponding risks’); [Bluefield, 

supra, 262 U.S. at pp.] 692-693 (‘A public utility is entitled to such rates as will permit it 

to earn a return ... equal to that generally being made at the same time and in the same 

general part of the country on investments in other business undertakings which are 

attended by corresponding risks and uncertainties.’).” (Duquesne, supra, 488 U.S. at 

pp. 314-315.) 

Duquesne also affirmed the rule articulated in Hope that no particular method or 

formula is constitutionally required. (Duquesne, supra, 488 U.S. at pp. 310, 314.) “[A]n 

otherwise reasonable rate is not subject to constitutional attack by questioning the 

theoretical consistency of the method that produced it.” (Id. at p. 314.) “ ‘It is not theory 

but the impact of the rate order which counts. If the total effect of the rate order cannot 
19.

be said to be unreasonable, judicial inquiry...is at an end. The fact that the method 

employed to reach that result may contain infirmities is not then important.’” (Id. at 

p. 310, quoting Hope.) Other Supreme Court cases are to the same effect. (See, e.g., 

Verizon Communications, Inc. v. F.C.C. (2002) 535 U.S. 467, 525 (Verizon) [noting 

general rule that any question about the constitutionality of rate setting is raised by rates, 

not methods]; Federal Power Com. v. Natural Gas Pipeline Co. (1942) 315 U.S. 575, 

586 (Federal Power) [“The Constitution does not bind rate-making bodies to the service 

of any single formula or combination of formulas .... If the Commission’s order, as 

applied to the facts before it and viewed in its entirety, produces no arbitrary result, our 

inquiry is at an end”].) 

III. PUC Decision Not Shown to be Unconstitutional

Petitioners contend the cost of capital determination was so unreasonably low it 

was confiscatory (i.e., a taking) in violation of their constitutional rights. 

The burden is on petitioners to show the rate of return (or cost of capital) 

established by the PUC was clearly confiscatory. That is, there must be a clear showing 

the rate of return was “so ‘unjust’ as to be confiscatory,” such as by demonstrating the 

rate is so unreasonably low it will threaten the utility’s financial integrity by impeding the 

utility’s ability to raise future capital or adequately compensate current equity holders. 

(Duquesne, supra, 488 U.S. at pp. 307, 312, italics added; Hope, supra, 320 U.S. at 

p. 605; see, Verizon, supra, 535 U.S. at p. 524.). A rate of return lower than the utility 

asserts is necessary may nevertheless be reasonable or within a range of reasonableness, 

constitutionally speaking, if it is “ ‘higher than a confiscatory level.’ ” (Duquesne, supra, 

488 U.S. at p. 308; Federal Power, supra, 315 U.S. at pp. 585-586 [explaining there is a 

zone of reasonableness within which the Commission is free to fix a rate as long as it is 

higher than a confiscatory rate].) 

As our state’s highest court put it: “The standard is that of reasonableness. One 

challenging a rate-fixing order on constitutional grounds of confiscation is charged with 
20.

the burden of showing that the evidence does not support the commission’s findings and 

that the rate as finally fixed is unreasonable and will result in confiscation. Such burden 

is coupled with a strong presumption of the correctness of the findings and conclusions of 

the commission, which may choose its own criteria or method of arriving at its decision, 

even if irregular, provided unreasonableness is not ‘clearly established. Thus 

responsibility for rate fixing, insofar as the law permits and requires, is placed with the 

commission, and unless its action is clearly shown to be confiscatory the courts will not 

interfere.’ ” (PacTel, supra, 62 Cal.2d at p. 647; see also pp. 656-658.) Unless the party 

challenging the PUC decision demonstrates the amount fixed as a fair rate of return is 

“clearly unreasonable,” this court may not substitute its judgment for that of the PUC. 

(Southern Cal. Gas Co. v. Public Utilities Com. (1979) 23 Cal.3d 470, 484.) 

Moreover, the facts presented must clearly show the PUC’s decision denied 

petitioners their constitutional rights. “[M]erely asserting in general language that rates 

are confiscatory is not sufficient .... [I]n order to invoke constitutional protection, the 

facts relied on must be specifically set forth and from them it must clearly appear that the 

rates would necessarily deny to plaintiff just compensation and deprive it of its property 

without due process of law.” (Public Service Com’n of Montana v. Great Northern 

Utilities Co. (1933) 289 U.S. 130, 136-137, italics added.) 

Here, petitioners contend they were deprived of a reasonable rate of return under 

the standards set forth in Bluefield, Hope and Duquesne. Petitioners argue that because 

the PUC did not adopt their methodology of applying additional risk premia relevant to 

small rural carriers, or did not otherwise specifically account for the risk factors itemized 

by petitioners, they have been denied a constitutionally reasonable rate of return and, 

therefore, the rate of return was confiscatory. On the record before us, we disagree. 

As more fully discussed in part IV of this opinion, the PUC’s methodology of 

calculating the cost of equity component of the cost of capital under a two-step approach 

(i.e., risk-free rate plus an equity risk premium) while using corroborating data to check 
21.

the reasonableness of the outcome, was not so patently flawed or irregular that we must 

reject it out of hand. It bears repeating that an otherwise reasonable rate is not subject to 

constitutional attack by questioning the consistency of the method that produced it. 

(Duquesne, supra, 488 U.S. at p. 314.) Rather, if the total effect of the rate order cannot 

be said to be unreasonable, judicial inquiry is at an end, and the fact the method 

employed has serious infirmities is not then important. (Id. at p. 310; see, Verizon, supra,

535 U.S. at p. 524 [questions about the constitutionality of rate setting is raised by rates, 

not methods]; Federal Power, supra, 315 U.S. at p. 586.) For these reasons, the PUC’s 

methodology does not adequately establish petitioners’ claim. 

Additionally, petitioners rely on the fact they presented evidence of certain 

business or investment risks that the PUC did not incorporate or account for in its cost of 

capital analysis. However, as will be seen in part IV, after weighing all of the evidence 

before it, including that of ORA and petitioners, the PUC appears to have reached a cost 

of capital result that was nonarbitrary and within a range of reasonableness. (See Federal 

Power, supra, 315 U.S. at p. 586 [“If the Commission’s order, as applied to the facts 

before it and viewed in its entirety, produces no arbitrary result, our inquiry is at an 

end”].) Additionally, in regard to petitioners’ precise claim the cost of capital was so 

unjust as to be confiscatory in its impact, we agree with the PUC’s argument that 

petitioners’ evidence was largely of a generalized or theoretical nature.7 

We conclude petitioners have not clearly demonstrated the PUC’s cost of capital 

determination, utilizing a cost of equity of 10.80 percent, was so unjust as to be 

 

7 The PUC also notes the constitutional challenge is arguably premature because 

cost of capital is only one component of eventual ratemaking, and therefore it cannot be 

definitively shown at this point in the process that the impact will be confiscatory. Since 

we conclude petitioners’ constitutional challenge falls short, we need not reach the 

alternative argument of prematurity.
22.

confiscatory, or that it was clearly unreasonable or arbitrary under all the circumstances. 

Petitioners have not met their burden of establishing a constitutional violation. 

IV. PUC Decision Not Arbitrary, Capricious or Lacking Evidentiary Support

Petitioners’ claim that the PUC’s decision on the cost of equity component of the 

cost of capital “rest[ed] upon arbitrary and capricious reasoning that ha[d] no foundation 

in record evidence or legal precedent.” In particular, petitioners argue the PUC’s refusal 

to apply the additional risk premia (i.e., for the small size of the companies, and industryspecific or regulatory risks) to increase the rate of petitioners’ cost of equity was not 

supported by substantial evidence in the record or reasoned argument. Petitioners point 

out that the PUC’s rejection of these risk factors was particularly unreasonable in light of 

the constitutional standard that rate of return determinations should be commensurate 

with returns on investments in other enterprises having corresponding risks. Petitioners 

reiterate that their cost of equity analysis was backed by Balhoff’s expert testimony

presenting the evidentiary basis for the adoption of additional risk premia. 

The PUC responds that it reached a reasonable decision on the cost of equity 

which considered and weighed all the evidence, but ultimately found unpersuasive 

petitioners’ expert’s testimony that the several additional risk premia should have been 

applied to the cost of equity in this case. Further, the PUC argues it was not required to 

adopt petitioners’ method or formula for calculating the cost of equity, and in any event 

the result reached was within a range of reasonableness and was supported by evidence in 

the record and reasoned argument. We conclude petitioners have failed to meet their 

burden of demonstrating the PUC’s determination was arbitrary, capricious or lacking 

evidentiary support.

As noted, section 1757 requires that PUC decisions be supported by findings, and 

the findings must be “supported by substantial evidence in light of the whole record.” 
23.

(§ 1757, subd. (a)(3) & (4).)8 A party challenging a PUC finding for lack of substantial 

evidence must demonstrate that, based on the evidence before the PUC, a reasonable 

person could not reach the same conclusion. (PG&E, supra, 237 Cal.App.4th at p. 839.) 

Further, if an agency decision is shown to be “arbitrary” (see Woodbury v. BrownDempsey (2003) 108 Cal.App.4th 421, 438) or to “exceed[] the bounds of reason,” an 

abuse of discretion will be found. (See San Pablo Bay Pipeline Co. LLC v. Public 

Utilities Com. (2013) 221 Cal.App.4th 1436, 1460; § 1757, subd. (a)(5).) As our 

Supreme Court observed in another context, arbitrary decision-making is precluded: “A 

court will uphold the agency action unless the action is arbitrary, capricious or lacking in 

evidentiary support.” (California Hotel and Motel Assn. v. Industrial Welfare Com. 

(1979) 25 Cal.3d 200, 212 [a rational connection needed between the agency’s 

consideration of relevant factors, the choice made, and the purposes of the enabling 

statute].) We also keep in mind the “strong presumption of the correctness of the findings 

and conclusions of the commission, which may choose its own criteria or method of 

arriving at its decision, even if irregular, provided unreasonableness is not ‘clearly 

established.’ ” (PacTel, supra, 62 Cal.2d at p. 647.) 

In deciding whether there was substantial evidence to reasonably support the 

PUC’s decision-making on these matters, we will review the parties’ arguments and 

evidence regarding the separate risk premia asserted by petitioners, including (1) the 

small size of the companies, (2) industry-specific risk, and (3) regulatory risk. 

 

8 Findings of fact and conclusions of law must be separately stated in PUC 

decisions, which “ ‘afford[s] a rational basis for judicial review and assist[s] the 

reviewing court to ascertain the principles relied upon by the commission and to 

determine whether it acted arbitrarily ....” (California Manufacturers Assn. v. Public 

Utilities Com. (1979) 24 Cal.3d 251, 258-259; § 1705.) 
24.

A. Alleged Risk Premia for Small Size of Telephone Companies

Petitioners requested a risk premium of 5.78 percent be added to the cost of equity 

due to special risks relating to the small size of the telephone companies. Balhoff 

presented his expert opinion based on certain studies that investors “require a return for 

smaller companies that exceeds that predicted in the CAPM for larger companies.” 

Balhoff stated that a “premium is appropriately added to the equity return to reflect 

market-based risk that is greater for smaller companies compared with larger companies.” 

In support of this conclusion, he explained that typically larger companies have the 

advantages of scale and are therefore more efficient than smaller companies. Among 

other things, he noted that “[g]reater size permits carriers to spread marginal costs over a 

large number of customers, and small firms are severely disadvantaged in managing their 

costs. As a result, small carriers require more federal and state support to supplement 

their investments and operations, while keeping rates within reasonable bounds.” 

Further, according to Balhoff, in addition to having greater efficiencies that tend to 

reduce operating costs and allow diversification of operations, larger companies 

(including larger LEC’s) generally have “extensive access to publicly-traded equity 

capital and cost-effective debt capital.” For these reasons, Balhoff stated: “Smaller 

companies are less able to deal with significant events that affect revenues and cash flows 

than larger companies. For example, the loss of sales from a few large customers would 

exert a far greater effect on a small company ....” (Quoting Roger A. Morin, New 

Regulatory Finance (Vienna, VA; Public Utilities Reports, Inc., 2006), at p. 187.) 

Petitioners also referred to the 1997 PUC decisions that, in setting a 10 percent 

return on rate-base for petitioners, mentioned the potential effect of company size. For 

example, the 1997 PUC decision relating to Sierra Telephone Company, Inc., 

acknowledged that consistent with the Hope case, the “adopted return on rate base” must 

provide “an opportunity to earn an equity return equivalent to returns on alternative 

investments in other firms with comparable risk.” (In re Sierra Telephone Co. (1997) 
25.

71 Cal.P.U.C.2d 506, 97 Cal. PUC LEXIS 1245, at p. *29.) The applicant had argued a 

30 percent increase to the cost of equity would be warranted due to its small company 

size. On that issue, the 1997 PUC decision stated as follows: “We do not necessarily 

concur with applicant’s 30% risk premium to compensate applicant for its small size as 

compared to the large companies in the study group. However, we do concur that 

applicant’s risk is impacted by its small size in relation to the large size of the companies 

in the study group.” (Id. at p. *32.) According to petitioners herein, even though the PUC 

did not adopt a specifically quantifiable size premium in its 1997 decision reaching a 

10 percent overall return on rate base, it at least acknowledged it was a factor to be 

considered.9

In response to the above evidence, ORA submitted its own report and analysis 

prepared by three of its staff members, each of whom possessed expertise to address 

issues discussed in distinct sections of the report. At the PUC administrative hearing at 

which oral testimony was presented, the three ORA staff members each adopted a portion 

of the report as his or her own testimony. ORA’s position on cost of equity in the report 

was that petitioners’ proposal of 18.5 percent cost of equity was excessive and 

unreasonable because, among other things, it did not account for significant market 

changes that have occurred since 1997 (the year when the PUC adopted 10% as the cost 

of capital, reflecting an implied average cost of equity of 12.15% at that time), including 

that regulated utilities’ return on equity and cost of debt have been steadily declining for 

the last two decades. Under all the circumstances, ORA believed its recommended cost 

of equity of 8.79 percent would more reasonably reflect investor’s expectations. The 

 

9 The PUC’s response to the above-quoted language from its 1997 decision is that 

no size premium was actually adopted by it in the 1997 decision, nor ever, and even if the 

1997 decisions could be so construed, the PUC is not bound by its past decisions. (See 

Re Pacific Gas & Elec. Co. (1988) 30 Cal.P.U.C.2d 189, 223.)
26.

8.79 percent figure was based on a recommended equity risk premium of 5.88 percent10

and a recommended cost of debt of 2.91 percent, with no additional risk premia. 

ORA’s report specifically criticized Balhoff’s recommendation to apply an 

additional premium for the purported small firm risk. ORA referenced a 2013 FCC staff 

report that had expressly declined to apply a risk premium based on small company size, 

and one of ORA’s exhibits was a 2011 study of financial literature arguably calling the 

small firm effect into question.11 However, ORA’s main assertion was that a size 

premium was unnecessary since a fair cost of equity could be reached by the method of 

adding the risk-free rate and the equity risk premium, and in any event the CHCF-A and 

USF programs provided additional protection to these small telephone companies against 

revenue risks. 

ORA asserted its total cost of equity recommendation was corroborated by a proxy 

group of communication firms derived from the 2013 FCC staff report and by data 

collected in a university study relating to the telecommunications services market in 

2014. Additionally, ORA pointed out that petitioners have apparently had no difficulty 

earning their authorized rate of return, notwithstanding petitioners’ insistence that the 

return on equity should be set much higher than previously. In this regard, ORA noted 

that during the past five years, petitioners earned an average rate of return of 

9.449 percent, which is very close to the authorized rate of return of 10 percent, with an 

average return on equity during that period of 11.973 percent. ORA also noted that a 

 

10 ORA’s equity risk premium of 5.88 percent was based on the 2013 Federal 

Communications Commission (FCC) staff report averaging equity premiums over a 

period of many decades, and, according to ORA, is also within the range of (and slightly 

above) the average implied equity premium of 5.13 percent reflected in the PUC’s 1997 

Small LEC decisions. 

11 The 2011 study was entitled, “A Literature Review of the Size Effect,” by 

Michael A. Crain. 
27.

2016 FCC order endorsed the approach taken in the 2013 FCC staff report and also found 

a rate of return in the range of 7.12 percent to 9.01 percent to be reasonable.12 

In his written rebuttal testimony, Balhoff criticized ORA’s reliance on the 2013 

FCC staff report because, among other reasons, (i) the proxy group used was allegedly 

different from the very small rural LEC’s in this case, (ii) the 2013 FCC staff report’s 

recommendation not to include a size premium was conclusory and, in any event, was 

apparently limited to the record before the FCC at that time, and (iii) the 2011 study of 

the literature addressing company size effect allowed that there may still be a size effect 

in the smallest companies, which was the case here. Balhoff claimed it was inapt for 

ORA to rely on declines in rates of return for water and energy companies, since 

petitioners face risks these other types of utilities do not. Petitioners also criticized 

ORA’s “selective reading” of the FCC’s recommendations on cost of capital in the 2016 

FCC order, which had indicated a rate of return that would taper down to 9.75 percent 

over a period of several years. 

The oral testimony presented at the administrative hearing included crossexamination of the experts, including further consideration of the evidence relied on by 

petitioners and ORA in their analyses of the effect of small company size. During ORA’s 

cross-examination of Balhoff, ORA introduced evidence Balhoff previously had testified 

in another forum that, in some contexts, a smaller firm breaking off from a larger one 

might be operated with more focus and efficiency. Patrick Hoglund was ORA’s expert 

witness at the hearing regarding cost of equity. On cross-examination, Hoglund agreed 

 

12 The 2013 FCC staff report and the 2016 FCC order are more fully described in 

the PUC decision in this case, respectively, as follows: (1) FCC Wireline Competition 

Bureau Staff Report “Prescribing the Authorized Rate of Return” (the 2013 FCC staff 

report) DA 13-111, WC Docket No. 10-90, May 16, 2013; and (2) In re Connect America 

Fund, ETC Annual Reports and Certifications, and Developing a Unified Intercarrier 

Compensation Regime, FCC Order 16-33 at ¶ 300, WC Docket No. 10-90, WC Docket 

No. 14-58, CC Docket No. 01-92 (March 30, 2016) (the 2016 FCC order). 
28.

“regulatory” risk is something that should be considered, but he believed it was 

adequately mitigated by the CHCF-A program. He was aware of the standards in the 

Bluefield and Hope cases as overarching goals, even though his analysis in the ORA 

report did not overtly address those case standards as such, but simply pursued what 

would be a fair and reasonable cost of equity. He also acknowledged on crossexamination that the proxy group selected from the FCC report for estimating cost of 

equity involved larger communication companies, but he explained he was mainly 

referencing them as “a check” on his return on equity computations. 

The PUC, after having weighed and considered all the evidence and argument on 

this issue, concluded as follows in the PUC decision: 

“We are not persuaded the evidence submitted supports a market risk premium 

specifically based on small firm effects. Applicants cite to some financial 

literature to support [their] claim that relatively small and privately-held 

companies have a higher cost of capital than relatively large companies. However, 

even if the literature supports the premise that size effects [d]o exist in the smallest 

firms, the analysis fails to isolate and weigh the specific advantages and 

disadvantages of the Small LECs rate-of-return regulatory classification, and thus 

does not necessarily apply to the Small LECs in this application. ... In evaluating 

the issues raised in Applicants’ testimony we find those issues to be stated in a 

general or hypothetical way. Applicants did not apply those general or 

hypothetical examples to their specific circumstances and situations, and thus we 

cannot determine if the general assertions apply to them. Further, the record does 

not demonstrate in a quantifiable way how a Small LEC that is regulated as a rateof-return carrier compares to the typical small or ‘microcap’ firm that operates in 

the U.S. economy as a whole. Accordingly, Applicants have failed to carry their 

burden to show that Applicants’ risks are impacted by their small size in a way 

that would justify a specific size premium in this case.” (Fns. omitted.)

In its decision on this issue, the PUC also observed it is required to provide 

subsidies under the CHCF-A program sufficient to meet the revenue requirements for 

each small LEC. These subsidies provide a means to address some of the possibilities 

indicated by applicants; and while the CHCF-A program does not eliminate all business 

risk to the small LECs, it helps to “mitigate the business risk these companies face.” In 
29.

the PUC’s regulatory assessment, the state subsidy programs13 provide “a sounder 

regulatory structure balancing utility incentives and customer costs than we could achieve 

through the provision of an adjustment for firm-size effects to the cost of capital for the 

Small LECs.” 

Based on the foregoing summary, and upon our consideration of the entire record, 

we conclude the PUC’s decision to not include a special risk premium for the purported 

small-company size effect was not arbitrary, capricious or unsupported by substantial 

evidence. Rather, it appears to us the PUC carefully weighed and considered all of the 

evidence and circumstances presented and reached a rational conclusion. As noted in our 

summary above, the evidence before the PUC included ORA’s evidence (i) questioning 

the small size effect and (ii) arguably corroborating through a variety of data comparisons 

(e.g., FCC reports) that the cost of equity could be fairly and reasonably ascertained in 

this particular case by applying appropriate inputs for the risk-free rate and the equity risk 

premium without warranting the addition of a special risk premium for small company 

size. Moreover, in weighing and evaluating petitioners’ evidence, the PUC was entitled, 

in this its field of expertise, to conclude such showing was not convincingly applicable to 

these small rate-of-return telephone companies. 

We are unable to conclude that, on this record, no reasonable person could have 

made the determination the PUC did. (See, Clean Energy, supra, 227 Cal.App.4th at 

p. 649.) Moreover, we do not reweigh the evidence. In view of the strong presumption 

of validity with respect to the PUC’s decisions, and in light of the entire record, we 

conclude petitioners have not met their burden of affirmatively demonstrating that the 

 

13 The PUC noted that, under section 275.6, the CHCF-A subsidy is an “after-thefact” type of calculation: “We calculate the revenue requirement first and then the 

CHCF-A provides subsidies to meet that revenue requirement if it is not already being 

met through rates. The calculated revenue requirement includes the cost of capital. 

Thus, while it does not eliminate all business risk to the Small LECs, the presence of the 

CHCF-A subsidies mitigates the business risk these companies face.” 
30.

PUC, in its refusal to include a small-firm risk premium, committed prejudicial error. 

(PG&E, supra, 237 Cal.App.4th at pp. 838-839 [summarizing burden in challenging PUC 

findings].)

B. Alleged Industry Risk Premium

Petitioners also sought an industry-specific risk premium, apparently premised on 

the added risk above the general equity market of investing in the telecommunications 

industry, due to such factors as changes in technology, competition and other forces. 

Focusing on a proxy group of selected companies, Balhoff calculated a 1.06 “beta” 

multiplier from the proxy group, resulting in an estimated industry risk premium of 

between .30 percent and .42 percent. 

The PUC found the evidence speculative and unconvincing for the following 

reasons: “Applicants offer no basis for comparing their selected proxy group to their 

particular circumstances, making any conclusion from the analysis done on the proxy 

group speculative. Thus, while the proxy group selected by Applicants may have an 

average beta of 1.06, Applicants failed to show how the risks faced by the proxy group 

correspond to the Applicants, why only five companies were selected from the industry 

code for the proxy group, or how the returns on investment for the Applicants correspond 

to the proxy group. Accordingly, Applicants failed to carry their burden to justify the 

addition of an industry-specific premium to the cost of equity calculation.” (Fns. 

omitted.) 

We agree with the PUC’s assessment of the deficiencies of the evidence. 

Moreover, the PUC reiterated the reasons mentioned in the small size analysis for 

concluding this additional risk premium does not appear to be necessary in this case. On 

balance, we conclude the PUC’s decision declining to apply an additional risk premium 

based on the specific industry was, on this record, a reasonable one.
31.

C. Alleged Regulatory Risk Premium

Petitioners also sought the adoption of a risk premium of at least 2 percent to the 

cost of equity based on regulatory risk, which was requested in the event the size 

premium was denied. According to Balhoff, a regulatory risk exists regarding these 

small and vulnerable carriers that are dependent on support mechanisms such as CHCF-A 

program funding and federal high-cost USF funding. He stated this dependence on 

revenue support programs creates uncertainty in the current legal environment where the 

FCC has adopted ongoing regulatory reforms and where corresponding reforms of the 

PUC regulations implementing the CHCF-A program are also being considered. Such 

uncertainty was assertedly a matter of concern to investors. For example, changes at the 

federal level (initiated in 2011) included a phase down of certain access charges over nine 

years as well as caps on certain operating expenses. Balhoff noted the PUC has “adopted 

a rebuttable presumption that Independent Small LEC’s revenue requirements could not 

include corporate expenses beyond the levels applicable to federal support mechanisms,” 

thereby placing a limitation on the use of CHCF-A funding. 

ORA, in its reply brief filed in the PUC proceedings, responded to the identical 

contentions that the regulatory reforms created a “regulatory risk” increasing the cost of 

equity. It stated: “For example, they cite to a ‘phase-down of interstate and intrastate 

access charges over a period of nine years’; however, any shortcomings in revenue have 

been and will continue to be met by the [CHCF-]A-Fund. They cite to ‘new broadband 

deployment standards that must be met’; but the [CHCF-]A-Fund specifically provides 

that these broadband infrastructure improvements will be put into rate base. They cite to 

a ‘new cap on corporate operations expenses’; however, the cap has been found by both 

the Commission and the FCC to be reasonable and necessary because of carriers’ 

inclusion of unreasonable expenses in ratemaking forecasts. They cite to the reduction of 

‘Safety Net Additive and Local Switching Support mechanisms’; but again, any shortfalls 

in revenue as a result will be covered by the [CHCF-]A-Fund. [¶] Even assuming that 
32.

these perceived ‘risks’ constituted an actual threat to revenues, which they do not, the 

carriers have maintained a healthy average return on equity of 11.973%, and have never 

been turned down on any loan application by the RUS or any other lender. It is clear that 

these ‘risks’ are merely imagined for the sake of producing higher returns than 

necessary.” 

Petitioners have a more limited view of the overall impact of the CHCF-A 

program to mitigate risk. As Balhoff noted, each company’s CHCF-A revenue is set in 

its most recent rate case, and that annual funding level remains effective until the 

company’s next rate case, subject only to limited annual adjustments based on specific 

factors prescribed in the CHCF-A rules. He noted further that an annual adjustment to 

CHCF-A funding levels can be made where the federal support component was less than 

forecasted, or for revenue impacts of regulatory changes of industry-wide effect that alter 

the assumptions upon which the PUC set the company’s rate structure in a rate case. 

In response to petitioners’ regulatory risk claim, the PUC decision held as follows: 

“Applicants have not offered persuasive evidence explaining how any of the alleged 

regulatory risks are not already adequately addressed through other regulatory means.” 

Judging from its entire analysis of proposed risk premia in the PUC decision, the 

reference to “other regulatory means” clearly included the CHCF-A program. In its brief 

filed with this court, the PUC elaborated that other regulatory means (besides CHCF-A 

program support) would include the right to apply for interim rate relief. 

Further, despite petitioners’ abstract claim of regulatory uncertainty, we note there 

is nothing in the record to indicate that the CHCF-A program has ceased to be an ongoing 

legislative or regulatory commitment. (See, § 275.6, subd. (g).) Thus, as the PUC put it, 

while the CHCF-A program does not eliminate all risk to the Small LECs, “the presence 

of [its] subsidies mitigates the business risk these companies face.” This conclusion was 

inferentially supported by ORA’s report discussing risk premia generally, ORA’s 

expert’s testimony on regulatory risk, and by the PUC’s agency expertise on the 
33.

operation of the CHCF-A program. In this connection, the presence of such 

countervailing factors may properly be considered. (Duquesne, supra, 488 U.S. at 

p. 314.) 

The PUC’s response to the purported regulatory risk claimed by petitioners was 

reasonable based on evidence in the record and on its understanding of the CHCF-A 

program and interim rate relief. On this record, petitioners have failed to meet their 

burden of demonstrating that these other regulatory means (i.e., the CHCF-A program 

funding and interim rate relief), as asserted by ORA and the PUC, would not address the 

identified regulatory risks. Additionally, for the reasons indicated in our discussion of 

small company size, the PUC had reason to believe, based on the record, that the cost of 

equity it assigned was within the reasonable range without the application of additional 

risk premia. Therefore, the PUC did not err in refusing to adopt a regulatory risk 

premium.

DISPOSITION

The California Public Utilities Commission’s decision Nos. 16-12-035 and 17-12-

029 are affirmed. Respondent is awarded its costs on appeal.

_____________________

SNAUFFER, J.

WE CONCUR:

_____________________

FRANSON, Acting P.J.

_____________________

SMITH, J.
34.

Filed 6/28/19

CERTIFIED FOR PUBLICATION

IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

FIFTH APPELLATE DISTRICT

THE PONDEROSA TELEPHONE CO., et al.,

Petitioners,

v.

CALIFORNIA PUBLIC UTILITIES 

COMMISSION,

Respondent.

F076845

(CPUC Decision Nos. 16-12-035 & 

17-12-029)

ORDER GRANTING 

REQUEST FOR 

PUBLICATION

On June 24, 2019, the Court received and filed Respondent’s request for 

publication of the nonpublished opinion filed on June 18, 2019 in the above entitled 

matter. In that the opinion meets the standards for publication specified in the California 

Rules of Court, rule 8.1105(c), it is ordered that the opinion be certified for publication in 

the Official Reports.

_____________________

SNAUFFER, J.

WE CONCUR:

_____________________

FRANSON, Acting P.J.

_____________________

SMITH, J.