Court Opinion

ID: 8513465
Source: CourtListenerOpinion
Date Created: 2022-11-23 08:46:16.136769+00
Date Added: 2024-06-11T16:51:11.500905
License: Public Domain

MOULTON, Chairman,
dissenting. While I agree with the conclusions reached by the majority as to determination of the rate base in this proceedings including the findings with respect to trending that portion of the depreciation reserve in excess of existing depreciation, the treatment of Western Electric price reductions, the added reduction from the rate base due to the revised valuation of retirements and the manner in which the depreciation reserve acquired from the predecessor company is dealt with, I cannot concur with the ultimate conclusions reach by the majority in this case and I therefore must dissent to the order which has been entered herein.
The crux of this case is the question as to whether or not the commission is to give consideration in the determination of just and *316reasonable rates for the applicant to the fact that the Ohio Bell Telephone Company has an all equity capital structure and therefore is in a unique position among practically all other telephone companies in Ohio and all other utilities as well.
It must be recognized at the outset that the cost of equity capital is much higher than that of debt capital and that, therefore, it follows that the subscribers of the company having all equity capital are called upon for a greater contribution than would be the case if a portion of the company’s capital structure consisted of debt. Testimony in this case as to the cost of servicing common stock ranges from 8% to 8V2% whereas the estimated cost of debt to this company is placed at 314 to 3%%. Another factor to be considered in this connection also is the impact of federal income taxes since interest charges incident to debt capital are deductible items of expense in computing income taxes, whereas of course, dividends on stock are not deductible so that at current tax rates it is necessary for the company to earn $1 in order to have 48c available for dividends or surplus. The question which we have to determine here is whether or not a regulatory body such as this commission should impute a reasonable ratio of debt to Ohio Bell for the purpose of testing the reasonableness of the rates which have been requested.
The company contends that the capital structure of a utility company is to be determined by management and that if the management decides it is to have no debt then the commission must recognize the situation as a “fait accompli” and not ask any questions but provide it with sufficient earnings to service such a structure. The cities on the other hand contend that the commission should pierce the veil which surrounds the capital set-up of Ohio Bell as an ostensibly independent company and look to the fact that all of Ohio Bell’s stock is owned by American Telephone and Telegraph, and to the fact that Ohio Bell’s corporate policies are in effect determined by its parent company which has imposed a policy of debt free capital upon its subsidiary solely and wholly for its own benefit at the expense of the subscribers of Ohio Bell. Obviously, American Telephone & Telegraph benefits handsomely from the arrangement whereby it acquires all of the common stock of Ohio Bell at par, receives a $7 annual dividend on its investment, and in turn borrows a substantial portion of the funds it uses for such investment at a cost of 3% to 3 1/4%. The most recent bond issue of American Telephone & Telegraph in the amount of $250,000,000 was sold on a bid of $101.9199 for a 3 1/4% coupon, giving the company a net cost of 3.15%. The fact is that the debt ratio of American Telephone & Telegraph is approximately 39% of its total capital and that while it as the parent company indulges in debt financing to its own advantage, it denies the same privilege to Ohio Bell. In weighing the respective merits of these two contentions I find it necessary to give the greater weight to the position of the cities because to do otherwise is to ignore the interest of the subscribers of Ohio Bell and I deem it the duty of this commission to protect and defend their interests. If this commission does not do so, then in my judg*317ment we have failed to perform one of the duties that has been assigned to us.
Ohio Bell’s capital structure consists of 3,175,000 shares of common stock at $100 par value, all of which is owned by The American Telephone & Telegraph Company. This, together with an earned surplus of $7,991,550 as of July 1, 1953, brings the total capitalization of the company to $325,491,550. Applying a factor of 91.38% to represent the portion of the investment devoted to intrastate operations results in a figure of $297,300,000 as the capitalization of the company on the date certain, i. e., July 1, 1953. Net operating income for the year ending June 30, 1953 amounted to $21,660,677 which is sufficient to pay a dividend of 6% on $290,000,000 and to permit an accumulation to surplus of $4,097,677, this being on the basis of a pay-out ratio of 81%. Experts for the company have testified that a pay-out ratio of 80% is conservative and reasonable.
For the year ending December 31, 1953 earnings per share of Ohio Bell stock amounted to $7.86 as against a five-year average of $6.13. Earned surplus as of December 31, 1953 amounted to $10,027,856 or $3.15 per share as compared with a surplus of $1.86 per share on December 31, 1952. The earnings per share of Ohio Bell for 1953 of $7.86 compare with the composite average of $7.42 per share for the eleven other principal subsidiaries of American Telephone & Telegraph. Testimony of witness Hirsch was to the effect that a 6% dividend on an 80-20 pay-out ratio afforded a generous return to the company. The company offered testimony indicating that a higher return was required. Hirsch’s Exhibit A-20 shows that top electrical utility stock had a yield of $4,83 at the end of the first quarter of 1954 and that during the highest peak of 1953 such stocks yielded no more than 5.5%. Certainly no one can deny that if Ohio Bell stock were on the open market it would be in at least as favorable a position as that of any other first quality utility common stock.
Ohio Bell is a part of a nation-wide system of telephone companies owned and controlled by the parent company, The American Telephone & Telegraph Company, and certainly this commission has a right if not a duty, to see what the other principal subsidiary companies are doing in this matter of capital structure. All of the eleven other principal companies owned by American Telephone & Telegraph have debt—the ratios ranging from 41.2% to 18.2% with a composite average debt of 27.6%. If we assume for the purpose of testing the reasonableness of the application herein that Ohio Bell had a 25% debt, which figure approximates the average debt of the other principal subsidiaries of the Bell system, then the earnings of Ohio Bell on its common shares for the year ending December 31, 1953 would on this pro forma basis have been $10.05 as against the system average of $7.42.
That it is proper for regulatory agencies to give consideration to hypothetical debt ratios in testing the reasonableness of rates has been well established in decisions by state commissions and by the courts. The Supreme Court of New Mexico in a recent decision said:
"Debt ratio is strictly a matter for management, but its evaluation *318in fixing rates is an item for serious consideration by the ratemaking body.” (New Mexico State Corporation Commission v. Mountain States Tele. & Tele., 4 P. U. R. 3d, 33.)
The Maryland Court of Appeals in a decision rendered in 1952 affirmed and approved the following statement made by the Maryland Commission:
“While having no power to direct the issuance of bonds instead of stock, we can say that the consumer should not be required to pay more than he would have had to pay if the company had availed itself of an appropriate debt equity capital structure.” (Chesapeake and Potomac Telephone Company v PSC 97 P. U. R., N. S. 50.)
The Supreme Judicial Court of Massachusetts in a recent case had this to say on the subject:
“Debt ratio substantially affects the manner and cost of obtaining new capital. It seems to us that to say the Department could. not even consider debt ratio would be to blind its eyes to one of the elements in the problem before it. Prom the standpoint of the company, it might be better to have no debt capital at all. An honest board of directors might think so and at least from the standpoint of loyalty to the company’s interest it would be difficult to say that they had abused their discretion. Yet the evidence shows that such a decision under present conditions might well double or even triple the cost of new capital and increase correspondingly the burden laid upon the public for obtaining it. Surely, the department could give consideration to this matter.” (New England Telephone and Telegraph Company v. Dept. of Public Utilities, 97 N. E. (2d), 509, 88 P. U. R., N. S. 73.)
In a recent decision by the New York Public Service Commission denying in full the application of N. Y. Telephone Company for a rate increase, the commission commented on the fact that the debt ratio of the New York company was substantially less than that of the Bell system as a whole and that this fact should be taken into consideration by the commission. The commission in the course of its opinion said:
“The New York Company’s debt ratio is presently substantially less than that of the Bell system as a whole and for the year 1953 was approximately 8 percentage points lower. To reach comparable figures, it would be necessary to average the debt ratio. Any such computation would, of course, again reduce the earnings per share required from the New York Company to pay its proportionate share.
“Since, debt financing, within reasonable limits, is cheaper than equity financing, a lower debt ratio in the New York Company as compared with the Bell system, tends (assuming the same rate of return) to load New York customers with a higher capital cost.” (Case No. 16548, dated August 5, 1954.)
As previously indicated American Telephone & Telegraph has debt in its capital structure amounting to approximately 39% and the eleven principal subsidiary companies have an average debt ratio of 27.6%. The company itself through its testimony relating to the cost of money assumes a debt ratio of 33-1/3%. Taking these facts into consideration and being mindful that it is always prudent to keep debt at a conserva*319tive figure, a capitalization for Ohio Bell which would include 33-1/3% debt appears to me to be reasonable under all the circumstances.
With a debt of 33-1/3% and assuming the cost of interest on the debt at 3%%, the company would have a savings of $1,675,000 in federal income taxes and thus would have a net operating income at present rate of $23,335,677 for the year ending on June 30, 1953, the test period in this case. Interest charges on the assumed long term debt of $99,000,000 at 3%% would amount to $3,220,000 and interest on advances of American Telephone & Telegraph are $163,000 which subtracted from the net operating income figure given above leaves an adjusted net operating income of $19,952,677 which would enable the company to pay a 6% dividend on the remaining $191,000,000 of common stock and would leave an accumulation for surplus of $8,492,677, an amount more than double that actually accrued to surplus during the test period. This computation results in a pay-out ratio of only 57.5%. If we use the 80-20 pay-out ratio which has been testified to as reasonable and conservative, then there would be enough available to pay a 7%% dividend on the common stock and provide $5,627,677 for surplus which is substantially more than that accrued during the test year. This produces a composite yield on the capitalization of 6.08%. There was considerable variance in the expert testimony on cost of money for Ohio Bell, Dr. Dorau saying it was 6.5%, Martindell 6.8% and Wasick 6.22%, on the basis of 40% assumed debt. The purport of Hirsch’s testimony on the subject would seem to indicate his belief that 6.08% is a proper cost of money for this company. Though the yield of 6.08% is somewhat under the figures of the company’s experts on the cost of money, I am of the belief that as a practical matter Ohio Bell would have no trouble in securing adequate capital at the 6.08% cost figure since whatever may be said on the subject the fact is that Ohio Bell does not have to compete in the open market for capital. Furthermore, in my opinion the estimate of the cost of debt capital at 3%% to 3.65% is on the liberal side with a definite likelihood that actual experience would result in a lower rate. Thus at present rates and with a proper reconstruction of the capital structure of Ohio Bell, it appears that earnings are ample and sufficient to maintain the company in a sound financial position. It follows, therefore, that no increase in present rates is necessary when we apply this valid test. A public utility has a duty to maintain a capital structure fair to ratepayers and investors alike and yet sound from business standpoint. If a company fails to maintain such a structure, it is the duty of the commission to consider this fact in determining whether or not an application for increased rates is to be granted. Economy in capitalization is as much an obligation of a public utility as economy in operation.
Rate of Return:
There can be no doubt that under Ohio law due regard must be given to the reproduction cost new of the property used and useful in the furnishing of utility services. The law requires valuation of utility property to be on an RCN basis but the reasonableness of the rate of return is left to the discretion of the commission subject of course to review by the Supreme Court, By applying an inflated rate of return *320percentage to the hypothetical RCN value, which itself represents inflation, the result obtained is unjust enrichment of the applicant. With the assumption of 33-1/3% debt for Ohio Bell we find that the rate of return under present rates on the rate base as submitted by the company is 5.44%, and on the rate base of $422,848,444 as found by the majority of the commission, with which figure I agree, the rate of return is 5.52%. Measured by this standard the resulting return is in my judgment adequate and reasonable under all of the circumstances in this case.
For the purposes of evaluating the reasonableness of such a rate of return on an RCN rate base it may be well to here point out what the rate of return presently is on the basis of the actual dollars which the company has invested in its plant. The book cost of the company’s plant as of the date certain is $459,355,824, the intrastate portion of which is 91.3% of the total or $419,759,352. Deducting from this figure the sum of $88,317,368 for depreciation results in an original cost less depreciation rate base of $331,441,984 which is the figure comparable to the RCNLD rate base of $422,848,444. Applying to this rate base, representing the actual dollars invested in plant, the net operating income of $21,660,677 for the test year we find that the rate of return is 6.54%. And applying the figure of $23,335,677, the net operating income which results from the imputation of 33-1/3% debt, the rate of return under present rates becomes 7.04%. In terms of these comparisons therefore, it appears to me that a return of 5.52% on an RCN rate base is providing the company a fair and reasonable rate of return. The rate of return of 5.94% on the RCN rate base which results from the order of the’ majority of the commission is equivalent to a return of 7.58% on an original cost rate base.
The New York Commission in the recent New York Bell case held that a rate of return of 5.91% on an original cost rate base was sufficient and denied the company’s request for an increase in rates.
An examination of Wasick’s Exhibit 11 for the city of Akron showing actions by commissions all over the country in recent years in fixing rates of return in rate cases indicates that the range of returns allowed where net investment is used as the rate base is approximately from 6% to 6 y2 %. It would appear, therefore, that the present return of Ohio Bell of 6.54% on its original cost rate base which is 5.52% on the RCN base is substantially in accord with predominant regulatory practices throughout the country in recent years.
For the foregoing reasons, therefore, I dissent from the majority opinion granting the applicant an increase in its rates and charges and hold that by the application of valid tests to the reasonableness of the application it has been shown that the present rates of the company are sufficient to preserve its financial integrity and that, therefore, the application for an increase in rates should be denied.