Opinion ID: 1926458
Heading Depth: 1
Heading Rank: 6

Heading: Cost of Debt and Preferred Stock

Text: The determination of cost of debt and preferred stock usually does not involve complexities. Bonds and preferred stock carry a fixed yield provided by contract which can be readily ascertained. This is true in the instant case, but the parties disagree as to the proper source of the yield data. Having determined that the Bell System capital structure should be used for regulatory purposes, the Commission concluded that it would be appropriate and consistent to use the Bell System cost of debt and cost of preferred stock in deriving the fair rate of return. 15 P.U.R. 4th 87, 123. The agency's use of these cost rates, i. e., 6.8% as the cost of debt and 7.8% as the cost of preferred stock, was upheld by the district court. On appeal in this Court the utility contends the commission should have used the South Central Bell cost of debt of 7.61% because it has issued bonds to outsiders who are independent of the parent corporation. The company relies on New England Telephone and Telegraph Company v. Department of Public Utilities, 360 Mass. 443, 275 N.E.2d 493 (1971) in which the court held that, where a subsidiary utility corporation raises debt capital from sources independent of its parent corporation, the subsidiary's historic cost of capital should be used. Additionally, South Central Bell argues that the cost of debt adopted by the Commission will deprive its equity owners of the opportunity to earn a fair return and jeopardize its AAA bond rating. The Commission, on the other hand, contends that its determination was warranted for a number of reasons: South Central Bell's obligation to pay a relatively high average yield, 7.61%, results from its imprudent failure to issue more debt, instead of equity, in earlier years when debt capital was less expensive, and ratepayers should not bear the burden of a utility's imprudence. Since South Central Bell is wholly owned by A. T. & T., it is appropriate to evaluate equity and debt costs with reference to the Bell System financial structure. The Company's argument lacks credibility because its own witnesses in other cases have based their testimony on the debt costs of the Bell System. See, Re The Chesapeake & Potomac Telephone Co. of Maryland, 10 P.U.R.4th 211, 218 (Md.1975); Re Southern Bell Telephone & Telegraph Company, 10 P.U.R.4th 166 (S.Car.1975). The Massachusetts high court's holding in the New England Telephone & Telegraph case, supra, is inapposite because that case did not involve a wholly owned subsidiary, and use of the Massachusetts utility's actual cost of debt was justifiable as a means of protecting members of the public who owned a 29% minority share of the company's stock. South Central Bell's arguments are plausible but not irrefutable. The Commission's position may have infirmities but it is likewise reasonable and meritorious. When confronted with the same question, the Florida Public Service Commission concluded that use of the subsidiary's cost of debt would be improper because the regulatory agency had decided to utilize the parent corporation's capital structure in its determinations. Re Southern Bell Telephone and Telegraph Company, 83 P.U.R.3d 84 (Fla.1970). In a similar case involving a different utility, this Court approved the Commission's use of the parent company's cost of debt in regulating its subsidiary utility corporation. United Gas Pipe Line Co. v. Louisiana Public Service Commission, 241 La. 687, 130 So.2d 652 (1961). There, we said: The cost of debt capital has a contractual basis. While it is possible to determine the cost of this to [the subsidiary], we agree with the Commission that in view of the intercorporate relationship the most reliable means of determining the historical cost of debt is to look to [the parent corporation]. It is well established that, in making a determination of costs for rate purposes, the reviewing Commission may look through the corporate form of affiliated corporations and probe for economic realities. 130 So.2d at 660. The Commission is not required to accept uncritically for regulatory purposes the utility's corporate form or financial information. It is the agency's duty to look beyond superficialities for economic reality. Accordingly, the regulatory body was not obliged to treat South Central Bell as a free standing utility rather than a wholly owned subsidiary of A. T. & T., or as a corporation whose capital structure, cost of equity and cost of debt have been determined entirely by its own management and investors in the open market. By the same token, it was not unreasonable for the Commission to consider whether the utility's historical debt issuance policy had been unfair to the ratepayers. Because South Central Bell is wholly owned by A. T. & T., the parent company in the final analysis is responsible for the utility's capital structure and the quality of its capital debt. The Commission's decision to look through the corporate form and use the parent company's cost of debt was reasonable. The Court's function is to review the Commission's action for reasonableness, not to decide which party's theory is better or to substitute its judgment. The Commission's determination of this issue was correctly upheld by the district court.