One of the most contentious questions in public utility
regulation is what "fair" rate of return to allow investors. This
book spells out the advantages and disadvantages of the major
methods used to estimate the required rate of return. It is a
thorough review and critique that will prove valuable to all
members of the regulatory community - commissions and their staff,
legal and management counsel, and intervenors - and to students of
finance and regulation.The point of departure is the cost of
capital as a concept and the rationale for setting the allowed rate
of return equal to the cost of capital. On this basis a
comprehensive set of evaluation criteria are developed, including
theoretical, practical, and empirical aspects. With the conceptual
and methodological framework established, the authors proceed to
evaluate the five major estimation methods: comparable earnings,
discounted cash flow, capital asset pricing model, risk
positioning, and market-to-book ratio. In addition, they survey new
methods of estimating the cost of capital, such as the Arbitrage
Pricing Theory, that are likely to be used more frequently in the
future. Several related topics are treated in appendices. The goal
of the book is not to choose a single "best" method, but to provide
a systematic assessment of the strengths of each.The authors are
affiliated with Charles River Associates in Boston. Lawrence Kolbe
is Vice President, James Read is Senior Research Associate, and
George R. Hall is Vice President. A Charles River Associates
Study.
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