Capital Issue: Return of and Return On

An interesting question was asked after my keynote speech titled “Getting it Right: Depreciation Studies” given on September 15, 2025, at the Society of Depreciation Professionals (SDP) annual meeting in Kansas City Missouri. The question was prompted by a quote from a speech I attended given in 1981 by Charles A. Zielinski former Chairman of the New York Public Service Commission. Zielinski was referring to the failure by state regulators and the Federal Communications Commission (FCC) to recognize early on that the central switching stations of America’s telephone companies had become functionally obsolete with the introduction of digital switching. The new digital central offices replaced old electro-mechanical analog switches.

“And those (regulators) with a broad sense of fairness might also want to see whether the old technology was under-depreciated because of their past refusals to accelerate depreciation: or whether they allowed sufficiently high rates of return to reflect this particular risk they would, in effect, assign to shareholders.” [1]

The interesting question was whether I believed, as Zielinski had mentioned the possibility, that the risk of inadequate capital recovery in the telephone industry in the 1970s and 1980s was considered and accommodated in the rate-of-return estimation and approval.

My answer was “no” for several reasons.

Firstly, having worked in telephone depreciation in the 1970’s and working with Jospeh Brennan, a well-known, rate of return witness, I do not recollect that the possibility of capital not being recovered was a consideration explicitly discussed in rate of return testimony. Also, in 1981 I was a Commissioner on the State of Wisconsin Public Service Commission, and I had heard testimony on rate of return for the AT&T system as well as many of the independent telephone companies operating in the state. Capital recovery was not an issue for the rate of return witnesses.

Secondly, under the public utility regulatory scheme there is a separate procedure for estimation of annual depreciation rates. This procedure involves the preparation by the public utility, or its consultant, of a full depreciation study for all asset accounts followed by review and analysis by the regulator including public hearings. The deprecation rate recommended is based on the expert’s opinion of the economic service life of each asset including provisions for “functional” or even “extraordinary obsolescence.” The risk of capital under or over recovery is therefore discussed before the regulator as a separate topic from that of rate-of-return.

In my opinion, the rate of return witness must assume that whatever depreciation rates are in effect at the time of the rate-of-return study are correct. To assume otherwise would leave the rate-of-return witness open to cross examination along the lines of

Q. “How do you know the current depreciation rates are not correct?"

Q. “Have you prepared a full depreciation study with alternative depreciation rates?”

In case you were wondering, be advised that rate-of-return witnesses do not prepare depreciation studies to inform their rate-of-return testimony. At least I am not aware of that having been done in any rate case. I am aware that a number of SDP members have credentials to provide rate-of-return testimony, but the studies are not linked.

To sum up, depreciation studies are an important component of the cost-of-service regulatory process. Rate of return adjustments are not an alternative. In an era of new energy production, storage and delivery technologies regulators must adopt the best practices in depreciation including timely recognition of technological changes.

Capital Issue: Return of and Return On

By Branko Terzic