Regulatory Finance: Financial Foundations of Rate of Return Regulation

I The Institutional Setting for Rate of Return Determination.- 1 Rate of Return in Rate Cases: The Institutional Setting.- 1.1 Regulatory Practice: The Rate Case.- 1.2 Regulatory Practice: The Cost of Capital.- 1.3 Regulatory Practice: The Experience.- 2 Earned Rates of Return, Allowed Rates of Return and the Cost of Capital in a Historical Setting.- 2.1 Estimating the Cost of Equity with a Random Coefficients Regression Model.- 2.2 Deficiencies in Equity Returns 1963-1981.- 2.3 The Deficiency Index, Regulatory Climate and the Cost of Capital.- 2.4 Implications for Rate Case Testimony.- II Theory of Rate of Return Determination.- 3 Traditional Models: DCF and Comparable Earnings.- 3.1 The Conceptual Basis for Both Methods.- 3.2 The Value of a Firm with Internal and External Equity Financing.- 3.3 Determining the Allowed Rate of Return with DCF.- 3.4 Determining the Capitalization Rate, p.- 3.5 Determination of the Allowed Rate of Return with Comparable Earnings.- 3.6 Summary.- 4 Traditional Models: CAPM and Risk Analysis.- 4.1 The Investor and the Discount Rate.- 4.2 Growth and Risk.- 4.3 Using the CAPM Rate as a Discount Rate.- 4.4 Using the CAPM in Rate Cases.- 4.5 Summary.- 5 Recent Models: Arbitrage Pricing Theory.- 5.1 The Arbitrage Pricing Theory (APT).- 5.2 The Applicability of APT.- 5.3 More on the Applicability of APT.- 5.4 Some Observations on APT and Rate of Return Determination.- 6 Recent Models: Valuation of Contingent Claims and Regulation.- 6.1 The Brennan-Schwartz Model: Description, Extensions, and Solutions.- 6.2 Effects of Regulation on the Required Rate of Return.- 6.3 Implications of the Contingent Claims Model for Estimating the Cost of Capital.- 7 Issues in the Theory of Rate of Return.- 7.1 "Accurate" Models to Predict the "True" Required Rate of Return.- 7.2 A Theoretical Comparison of the Models.- 7.3 Summary.- III Methodologies for Rate of Return Determination.- 8 Methodology of Comparable Earnings and DCF.- 8.1 Methodological Issues Associated with Comparable Earnings.- 8.2 Methodology for Application of the DCF Model.- 8.3 The Dividend Yield-Growth Approach.- 8.4 The Market-to-Book Ratio-Earnings Approach.- 8.5 Summary.- 9 The Methodology for Risk Analysis.- 9.1 A Straightforward Application of CAPM.- 9.2 Issues in the Calculation of Beta.- 9.3 Issues in the Calculation of E(rm)-rf.- 9.4 Issues in the Calculation of rf.- 9.5 Calculating pin Practice.- 9.6 Summary.- 10 Methodology of Arbitrage Pricing Theory.- 10.1 Methodology for Determining the Number of Factors and Their Impacts.- 10.2 Determining the Identity of the Common Factors and Calculating the Required Rate of Return.- 10.3 Determining the Allowed Rate of Return Using APT.- 10.4 Conclusion on the APT Methodology.- 11 Issues in Methodology for Determining the Rate of Return.- 11.1 Comparison of Methodologies.- 11.2 Combining Methodologies.- 11.3 Some Observations on Methodology for Required Rate of Return Determination.- IV Judgment and Rate of Return Determination.- 12 The Past and the Present: Adapting to Change.- 12.1 A Simple Framework for Analysis of Changes: Application to Dividend-Yield Plus Growth.- 12.2 The Behavior of Other DCF Estimates.- 12.3 The Behavior of CAPM Estimates.- 12.4 The Behavior of APT Estimates.- 12.5 Summary and Conclusion.- 13 Factors Not Incorporated into the Models.- 13.1 Inflation and the Required Rate of Return.- 13.2 Capital Structure and the Required Rate of Return.- 13.3 The Regulatory Setting and the Required Rate of Return.- 13.4 Only Change is Constant.- 14 The Reliability of Rate of Return Judgment.- 14.1 Theory, Statistical Methods, and Reliability.- 14.2 The Prospects for Reliability.- 14.3 The Reliability of Judgments.- 14.4 A Final Comment.- 15 Beyond Rate of Return Regulation.- 15.1 Rate of Return Regulation and Disallowance Decisions by Regulators.- 15.2 Rate of Return Regulation and Economic Incentives.- 15.3 The Impact of Regulation on the Cost of Capital.- References.- List of Symbols.