The Commissioner’s Question: Why not more Debt?

Commissioner Throckmorton C. Cummings, a newly appointed Public Service Commission (PSC) member, was reviewing the thousand pages of pre-filed testimony and exhibits in the most recent electric utility rate case. He had a yellow highlighter in hand and was marking sections for later consideration. He looked up as his advisor Dr. Benjamin Payne entered his office. Cummings, a former State Senator, was familiar, as many legislators were, with some recent utility-related legislation but not with the details of utility ratemaking. For that reason, he relied on Payne who had been an economist on the PSC staff before Cummings appointed him as his advisor.

“Ben, I have been reviewing the public testimony is this case and I found something really interesting that makes common sense.”

“What is that Commissioner?”

“Well, a number of public witnesses have observed that utility debt is much less expensive than equity and wonder why the utility does not take on more debt.”

“Commissioner,” responded the adviser, “I think you may find the answer in the pre-filed testimony of the rate-of-return expert witnesses.  It’s probably covered in the testimony of both the utility’s witness as well as that of the staff witness. Let me see if I can find a reference in the pre-filed testimony.”

“While you are looking, can you give me the Cliffs Notes version?”

“No need, here it is in one of the expert’s pre-filed testimonies” Payne pointed to a page in the binder.

Q. “Isn't debt less expensive than equity?"

A. "Yes, other things equal, debt is less costly than equity. Nevertheless, regulators and financial markets recognize that too much debt is inherently risky.  A firm with a significant degree of indebtedness also has lower quality debt, and therefore, higher fixed financing costs, greater interest payments, and/or liabilities.  Such firms generally have lower debt ratings and, as a result, higher interest costs.  Moreover, a more highly leveraged firm (e., one with more debt) will have more expensive equity, in part because investors view highly leveraged firms as risky investments.”[i]

 

“There is more but that is the gist of it.” Payne concluded.

“So, he claims that both debt and equity costs increase with more debt. Then what is the objective here?” Cummings continued as he perused the pre-filed volume.

“Commissioner, as you will read and hear in testimony there are differences of opinion as to the impact of increased debt on the cost of capital.” Responded Payne, “Our objective as regulators is to estimate the combination of debt and equity which will provide the minimum rate of return (ROR) or weighted average cost of capital which will still attract debt and equity in capital markets to fund the necessary electric assets needed to provide service.”

“And we get the debt and equity cost estimates from the capital markets?” asked Cummings.

“Yes, Commissioner,” Payne hesitated and the added “you can cross examine the witnesses on that when you have them on the witness stand and for a general discussion of regulation and capital markets, I’ll get you a copy of the 2018 NARUC report The Interface between Utility Regulation and Financial Markets.”

[i] Cicchetti, Charlles Prefilled Direct Testimony, Puget Sound Energy, April 5, 2004