We frequently appear as experts and consultants on projects related to the appropriate cost of capital for electric, natural gas, pipeline, railroad, water, and other regulated network industries. For the estimation of the cost of equity, we rely on traditional measures such as the Capital Asset Pricing Model and the Discounted Cash Flow model, as well as innovative methods designated to estimate the cost of capital at a line-of-business level for companies considering vertical disintegration, for firms entering foreign markets, and for companies facing radical changes to their cost structure. We carefully evaluate traditional techniques to ensure that the results properly reflect current changing macroeconomic risks.
Our results reflect an evaluation of the business, financial, or other risks facing the client and, if applicable, considers the regulatory regime in the jurisdiction where our analysis will be used. We frequently provide expert testimony before regulatory bodies in North America, Australia and Europe; and before courts and arbitration panels regarding appropriate cost of capital, allowed rate of return, discount rate, and capital structure.
At the request of the British Columbia Utilities Commission, Brattle experts authored a report on methods commonly relied upon to determine the regulatory cost of capital and the practices of Canadian provinces. The Brattle team surveyed all Canadian provinces regarding recently relied upon estimation methods used to determine the cost of equity, cost of debt, and capital structure, as well as whether individual provinces had specific regulatory recovery mechanisms in place. The British Columbia Utilities Board continues to refer to our review in cost of capital proceedings and have accepted our description that ultimately the cost of capital is determined in the market place and an opportunity. The Commission has also accepted our recommendation that several cost of equity estimation methods be used and cites our report on key issues to consider such as: the importance of consistency between measurement variables, considering forward-looking measure, evaluating, the challenges in using accounting measures to measure the cost of capital.
Brattle principals have researched the impact of revenue decoupling on electric and natural gas utilities cost of capital in several different contexts and timeframes. For our article, “Decoupling and the Cost of Capital,” we assembled a detailed 10-year database of the market returns of 14 utility holding companies and a corresponding index to measure the precise level of decoupling within those companies. We found that statistical evidence does not support the hypothesis that the adoption of decoupling results in a statistically significant reduction in the cost of capital. This has been a general finding of our other studies.
For the Association of American Railroads, a Brattle expert reviewed the methodology relied upon by the Surface Transportation Board (STB) to determine the cost of equity for U.S. freight railroads, and provided expert testimony regarding the appropriateness of the methodology. Our testimony focused on the implementation of the Capital Asset Pricing Model and the cash-flow based three-stage DCF model along with a discussion of the merits and regulatory practice of using multiple methods to determine the cost of equity. For the Capital Asset Pricing Model our work focused on the appropriate market risk premium, where the STB concurred with us that the historical average MRP was a reasonable benchmark. For the DCF model, we showed that the existing model underestimated the cash flow that accrue to railroads, so the opposing party’s argument that it overstated the cost of capital was flawed. The STB accepted our recommendation to continue estimating cost of equity by assigning 50% weight to the Capital Asset Pricing Model using well-specified parameters including the average historical market risk premium and 50% weight to the cash-flow based multi-stage DCF model developed by Ibbotson. The STB thus accepted our recommendation and ultimately declined the opposing party’s appeal citing in part our work.
Brattle experts prepared a report for the European Commission’s Directorate-General (DG) for Communications Networks, Content & Technology that offers guidelines for EU-based National Regulatory Authorities (NRAs) to use when calculating an allowed rate of return—typically the weighted average cost of capital (WACC)—for electronic telecommunications operators with significant market power (SMP). The report outlines a common set of procedures for NRAs to use when estimating WACCs in the EU telecommunications sector that ensures that price differences reflect economic fundamentals, and is more reliable than the methods that were previously used and thus the new method is unlikely to be challenged by the European Commission.
Complex business and legal matters require intellectually honest and analytically rigorous solutions that are thoughtfully developed and clearly communicated. We apply economic and finance principles with uncompromising quality to achieve clarity in the face of complexity. Independent analysis, responsive execution, and compelling presentation. That’s Brattle. That’s the Power of Economics.