Alternative cost-of-capital concepts in regulation

Journal Article · Tue Aug 01 04:00:00 EDT 1978 · Land Econ.; (United States)

DOI:https://doi.org/10.2307/3146003· OSTI ID:7060298

Copeland, Jr, B L

At the present time two cost-of-capital concepts are more widely used than any other in regulation as a basis for determining the cost-of-equity capital. One of these is the discounted-cash-flow (DCF) concept which is based on a dividend valuation model of common stock prices. The other concept widely used in regulation is the comparable-earnings concept. The economic rationale for comparable earnings as a cost-of-capital concept presumes that investors have the opportunity to invest in direct investment and that the earnings on book value of alternative comparable investment opportunities is therefore properly considered to be the opportunity cost of capital. According to the National Association of Regulatory and Utility Commissioners, more than half of the state commissions presently rely upon or accept comparable earnings as a method of determining the cost of equity for public utilities. Only about one-third of the state commissions have indicated an acceptance of DCF. The paper begins with a review and critique of the comparable-earnings concept as it is applied in regulation, and argues, among other things, that the comparable-earnings approach violates a fundamental marginal condition necessary to achieve efficiency in the allocation of capital, and generally results in an overestimate of the cost of equity. The paper then reviews the corresponding strengths and weaknesses of the DCF approach and suggests that DCF embodies a proper concept of return at the margin that makes it preferable to comparable earnings as a regulatory tool for determining the cost of equity for public utilities. (MCW)

• Research Organization: Iowa State Commerce Commission, Des Moines
• OSTI ID: 7060298
• Journal Information: Land Econ.; (United States), Journal Name: Land Econ.; (United States) Vol. 54:3; ISSN LAECA
• Country of Publication: United States
• Language: English

Related Subjects

29 ENERGY PLANNING, POLICY, AND ECONOMY
290200 -- Energy Planning & Policy-- Economics & Sociology
293000* -- Energy Planning & Policy-- Policy
Legislation
& Regulation
ALLOCATIONS
CAPITAL
COMPARATIVE EVALUATIONS
COMPETITION
DOCUMENT TYPES
ECONOMICS
EFFICIENCY
INCOME
INVESTMENT
MARKET
PUBLIC UTILITIES
REGULATIONS
REVIEWS
RISK ASSESSMENT