ML20003B472
| ML20003B472 | |
| Person / Time | |
|---|---|
| Site: | Three Mile Island  |
| Issue date: | 12/11/1980 |
| From: | PENNSYLVANIA, COMMONWEALTH OF |
| To: | |
| Shared Package | |
| ML20003B456 | List: |
| References | |
| NUDOCS 8102120163 | |
| Download: ML20003B472 (133) | |
Text
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17 4 O 1 Eefore V. 2' THE DENNSYLVANIr c'ELIC .JT IC.TY COM' I5 3 ION 3 -40000-4h In re: 80051196 - Pennsylvania Public Utility Conaission, l et al. versus Metropolitan 3dison Company. Investi-3i gation into requested $76.5 million race increasa.
6i C-80072105 - Metropolitan _ Edison Comoany versus l Pennsylvania Public Utility Cornission. Complaint L d
? against temporary base rates fi::ed by che Commission
- in its Order of May 23, 1980 at I-790403C8.
3 i
R-80051197 - Pennsylvania public Utility Commission _,
nt al. versus Pennsylvania 51cceric Comoanv. Investi -
9 !l' j gation into requestes $67.4 million rate increase.
10 ]
] C-80072105 rannsylvania Electric Comnany versus_
31 l Pannsylvania Public Titility Cocnis sion. Complaint against temporary 'oase rates fi::ad by the Commission
- 2, in its Order of May 23, 1980 at I-79040308.
i 13 Hearings.
14 g --o00--
9 Stenographic report of hearin; he:.d in 13 ]j Hearing Room No. 3, North Office Building, 16 l Harrisburg, Pennsylvania , i l
17 Friday, 2 December 11, 1980 18 at 10:00 o' clock a.m.
I 19:
20 --cCo--
JOSEPH P. MATUSCHAK, ADMINISTRATIVS IN> JUDGE 21f
--o0o--
22 :l 23 ll APPEARANCIS :
i THIS DOCUMENT CONTAINS
(; 24, STmN A. MxCLAREN, SSQUIR3 P00R QUAllTY PAGES
. Deputy Chief Counsel 25? JULIAN S . SUFFIAN, ESQUIRI 3 Assistant Counsel v. w ;"'se 'm *'m:
r xesa nca a .unsut mc. - n a ' caw '
8102120l
o 1 1211 P
1 Before
( 2 THS PTNNSYLVANIA "UELIC UTILITY COMMISSION O 3 --oGo--
4 '
In re: R-80051196 - Pennsylvania Public Utility Commission, et al. versus Metropolitan Tdison Comoeny. Investi-5' gation into raquested $76.5 million rate increase.
6 C-80072105 - Metropolitan Edison Comcany versus Pennsylvania Public Utility Commission. Complaint 7; against remporary base rates fixed by the Commission
- in its Order of May 23, 1980 at I-79040308.
8 i
.R-90051197 'vennsylvania Public Utility Coemission, 9 et al. versus Pennsylvania llectric Comoany. Investia
! gatica into requested $67.4 million rate increase.
10 'i i C-80072106 - Pennsylvania Slectric Coapany versus Pennsylvania Public Utility Commisjion. Comalaint 11 j i against temporary base rates fixed by the Comoicsion in its Order of May 23, 1980 at I-79040308.
12 )d Hearings.
13 l 14 i --oCo--
13 Harrisburg, 'ennsylvania 16 December 11, 1930
( 17:! --c00--
18 Page's 1211 to 1343 l
19 .,
Il 1 t 20j 21, #
t i
l 22l MOHRBACH & MAR 9HAL, INC.
I ! 27 North Lockwillow Avenue '
23' Harris'ourg, Pennsylvania 17112 l e. 24l h s- t 25; i
u m ca . , m m . m e. - a n. ,c c m u.c - m . - ,y na,s - m om
[ ...
1212
. +
1 / $
c< i 1 !. * ).RANCIS: (Continued) !
4 1 I:h B0HDAli R. PAN 133, ESQUIRE ,
s Assistant Counsel i 4 li!
Rcom 19, North Gffice Building l
$ 9 O. Box 3265 !
4 !! Harrisburg, Pennsylvania 17120 i f vor - Co~nission Trial Staff i 5F i
^
d :
- , i SAMUEL RUSSELL. , ESQUIRE
.. Ryca, Russell & McCohaghey I y 5 530 Penn Square Center P. O. Box 699 i g ij Recding, Pennsylvanic 19503 !
h For - Metropolitan Tdison Co:npeny and j g
Pennsylvanis 31ectric Compcny ;
j DAVID DARASCH 3 ESQUIR3
,O ASHLEY SCHAMUER, ESQUIRS I 1425 Strawberry Square
, , , p 41 Hsrrisburg, Pennsylvsnia 17120
!i i For- Offic of Consumer tidvo:cte 12s i
j iS ! BERNARD A. RYAN, JR. , ESQUIRE
~q 800 North Third Street l
{- Harrisburg, Pennsylvania 17120 I
'7 '
h '
y For - Bethlehem Steel Corporation s'e li
!i KEIO*NETH A. WISE, ESQUIRE ,
$ 213A North Front Screet !
16 "! Harrisburg, Pennsylvania 17101 -
.b For - Louise Riley & SPAG i i
se i i l 9g !! DONALD F. SPANG, ESQUIRE
~
l! JOHN J. SPEIC?IR, ESQUIRE P. O. Box 1256 19 [ 528 Washington Street ,
i Reading, Pennsylvania, 19605 i For - American Society of Utility Investors 20l l 21h !
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A" IAQHRCr.CH & f4ARCHAt f MC. - 27 K t COMWit.t.OW AVE.- M Rnt*DVDO PA. 17112
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r RESPONDENTS DIRECT CROSS l h 3( Dr. Eugene F. Brigham 1214 1220 ,
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1 ij THE l.DMINISTRATIV5 TAW 20DGE: We have the' t
2 ,1 complaint of the e.marican Society of Utility Investors O 9
'1 i
3)docketedatR800511 CALM 0andthatisthecceplaintthstwe i B
4 l had deferred ruling on and of the three complaints filed n
N 5 by the American Society of Utility Investors, that is the 6 only co= plaint thst has been filed cgainst Met-Ed Company.
? 5 T he other two complaints were filad agcinst the Cocaiscien e
Sf itself and we are not assuming any jurisdiction in this t
9 h proceeding on that.
I 10 We will, however, consolidate the ii .
11 L complaint at 060 in this rate proceeding !
12 - MR. S"EICHER: Thank you, Your Honor.
, O. IS THE ADMINISTRATIVE IAW JUDGE: Any other I;
Og 14 h preliminary matters before we get started?
3 15'- MR. BURGRAFF: We have none.
W n
16 i TRE ADMINISTRATIVE IAW JUDGE: Are you 1
ft 17 l ready to proceed, Mr. Russell?
! p i 18 i MR. RUSSELL: Yes, sir. Met-Ed and Penelec j 19 j call Dr. Brigham.
I i 20 (Whereupon., DR. EUGENS F. BRIGEAM, having l
31 been first duly sworn, was called as a witness and testified 22 l as follows:
i '
23 ,f DIRECT EXAMINATION 4
24 E BY MR. RUSSELL: .
O 25 4
- Q Dr. Brigham, will you state your name and i
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- 1) cddress please? '
i
- i. Eugene F. Brigham, Graduate School of '
en' ,
, i Business Administration, University of F lorida , Gainesvi'..le. - ,
4 i 5' Floridt. I n i en 1,
't Q And are you employed by that institution 1 l 0
A Yes, I am. I ei i
Q In that capacity? ;
6'
- A I am a Professor of Finance and Directo
- e' "j of t he u ublic Utility Research Center.
10 ) Q Do you have before you a document which
..b 11 ' <
has heretofonsbeen marked for identification as Met-5d- I t
t
- 2 jj Penalec Statement H?
~ '
59
~~
..i A Yes.
g 19 Q Was that prepared by you or under your
- n ~c . . -
-- :i supervision c ,
I 1
'6 l. A Yes, it was.
- l 14 :i Q If I were today to ask you the same b
Ab questions that appear on that statement, would your answers to ?
--[k be the same as those contained in that statement?
204 A Yes, with the exception that conditions 21 have changed somewhat since the testimony was prepared.
Q /11 right , perhaps I will address that in 22 [4 l
23', a It T.inutes.
2t.'. it g Is there attached to Statement H an 25E h /ppendix A ? 2 l - 6 ownexcw e .itriswit. tac. - 22 r:< tecxwiuto a avs. - -unis eisac pa. iv,iz
Brieham-dire ct 1216
! / f i < . t i] A Yes. there is. !
2 Was t hat preptred by you or under your
(]) J Q
S d supervision? l l
4 A Yes. It was co-authcred by another person' i
5 7 at the University of Florida, but we jointly prepared it.
i ,
6dy 0 And it has been identified and described a .
7j briefly in your statement? .
2 2 'l A Yes. !
Do you also have before you a documset '
9] Q 10 j that has been marked for identifica: ion as Exhibit EFB-l?
+
n 11 A Yes. i E2 d Q Doas that consist of five schedules?
?
- 0 La
. . !j A Yes.
(~\
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14 l Q And that was prepared by you or under 6
l 15 gl your supervision?
n I
r ,
16,j A Yes, it was. !
. I i
17 Q ,
Are the respective schedules'of Exhibit 18: EFB-1 identified and explained in your statement?
I 19 A Yes , they are.
20 Q Dr. Brigham, could you for the record l
, 21 just briefly summarize the substance of your testimony?
t 22 A .Yes. The focus of my testimony is on the I I present evidence 23 cost of couity. for Met-Ed and Penalec.
N
! 24 I which shows that for a number of reasons the riskiness of th9 l4s(~') d the 25 utility industry has increased vis-a-vis that of/ industrials
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Brighsm-direct 1217 ,. ,,
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'l in recent ye ars . and this incretsef relative risk has led .
a tc an increase in the utility cost of capitel rela tive to I
lll a et
- ? that of the industrial. !
l
- 1 also analyze the risk position of Met-Edl, I
u;
' h Pen 21ec and GPU as a whole. My conclusion is that therishi-l ,
of the Uc publicly owned utilities and Met-Ed- -I a.m 1' 6 l': ness I
e <' i
- j sorry, ny conclusion is that prior to the Three Mile Island ga #
f Met-Ed, Penelec and GPU were about as risky as the j 9 l!average 3
accident.
US utility. but thst today GPU is the riskiest of I-d s
'O i i
the US publicly-owned utilities and that Met-Ed is somewhst ;-
E 11 , riskier than Penelec.
~~ !;
12 ,!f I use tuo methods to esti= ate -be cost of 13 N
-[ equity. The risk premium method where a risk premium is de-ggg g' C y added to the rate of return on/ fault-free US Treacury Bonds I:
-1 1s 1 and the DCF method, which recognizes that the rate of return i
~61 1
l which investors expect to earn on a stock is equal te a ,
b i 5
~7 J; divident yield plus a capital gain that rises from expected i, 4
18 E ' growth earnings and dividends.
n 19 9 ft. At the time Emy testimony was prepared in
~O '! July 1980, the treasury bond rate was ; bout 10 percent.
! My b
'1 ;l studies, which are summnrized in Schedule 3 and discussed in i
o Y
22 detail in Appendix A, indicated that the appropriate risk 0
23 ( premium is in the range of six to seven and a half percent.
24' Adding the risk premium to the treasury bond yield produced 25 r
[ an estimated cost of equity in the range of 17 to 18% percent.
" MOHRG ACH 6 mar:SMAL. fHC - 27 Nc LOOMVALLOW d VE. - H 4't RIS O U R G PA 17112
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I 1 T ha t includes a floatation cost adjustment to go from a d '
C 2 msrhe cost of capital to a fair rate of return on boch Ij equity.
? ;F The DCF method een be applied in two l
,'1 5 [ versions, a constant growth version and a version where che ,
a i 6 l expected growth rate is not escu:r.ed to remsin constant ever i d :
time.
7 li .
i Cf Further, one can apply the DCF method l B .
S' ;
i directly to the company in question. inthiscaseGPU,since!
10 ' its subsidiary's common stock does not trade in the market ,
ii 11 j er to a set of comparable companies. j
, i 12 $ I examined both the constant . and the ,
6 ti l
%- 13 li non-constant growth models, but the non-constant model best inet N.i ?
l .14 f,! the actual assumptions that exist for G"U, so I applied it 15 to GPU and also to a set of comparable companies and I should
'l I 16.3 note that the cc5e2able companies are companies that GPU j i i 17 would have been coEpalaEle to had the Three Mile Islad accident not occurred. The comparcble companies were taken I 18 l ,
19 to be the electric utilities which operate in Pennsylvanie l I and in the contiguous states.
20 ld 1
21 j In applying the DCF method, we need 22,5 estimates of investors' expectations of future dividends er,d i
l 2kl! growth in dividends, not the expectations of a rate of
.n.
f 24I return analyist. I used as the be'st available estimate of
%)
'w. l 25 the average investor's views the projectiont set forth in the l
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1 Value Line reports.
3 Based on tne value Lina datc, with CPJ ;
, G 3 3 projectione. I estimated the cost of equity to be within .
E 4y the range of 16 to 19% pa rcent. Based on the comparable f 51 cempanies , I found the DCF ccst of equity to be 16 percent. !
- ' i 6 All of these esticates were based cu conditions as they ii '
l
?; existed last stim 3r. As is c; ell known, inherent rates and a
l !)
S !! ccpital costs generally have risen since the testimony was :
3 9' completed and filed . T he risk premium methed today. uas ,
10fcreasurybondsyielding12.8 percent, Triple A Bell bonds i u :
a 11,] yielding 14.71 percent and BAA bonds yielding 17 to 18 ,
12] percent indicates a cost of equity of at least 19 percent. -
l 1 13 I' The DCF method, based on GPU data,
- n h 1 14 t indicates e cost of equity in the renge of 20 to 24 percent,j i:
j 15 ; while the DCF method based on compcrable companies indicatesi l i
16 a cost of equity of about 18 percent.
a A'
17 j That completes my sucunsry.
s 18 ij MR. RUSSELL: Dr. Brigham is available 0
19 q for cross-examination.
e 20 09 THE ADMINISTRATIV5 LAW JUDE: Who wants 1
N i
21y to proceed first?
e 1
22 MR. BURGRAFF: The Consumer Advocate will 1 .
23 , proceed first.
l 24[
25 l I
9 E McHRD ACH 4.14 ARCHAL. INC. - 27 N. LOCXWILLCW AVE. - H A 9 RIS 3 URG P A. 17t32
- Brighsm-cross 1220
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1h CROSS-EXI.MINATION I
y -
,() E SY MR. BURGRAFF: !
i r
ag Q Good morning, Mr. E righcm. l
.p !
- - l A Good morning, f Q In your sumccry, sir, you just gave uo l 0
0hsomeadditionalfigures.
Are ve to apply those figuras to {
7 GPU? Was that the intent ? It wasn't stated. I assume. !
8ij 'A I am simply giving you or giving the
, b 9 ! Commission an indication of what the cost of capital is er ,
10 h n
I estimate it to be, then it would be up to the Commission cq '
c 11 ij apply it as it sees fit. I am simply trying to estimate l W <
12 !l the cost of capital. I did it as of the time the testimony f l
13
(. } was prepared last summer and I simply up-dated it cnd the 14 0 Commission would use it as it sees fit.
f.
15I TF2 ADMINISTRATIVE IAW JUDGE: Well: the 16 j cost of capital that you gave, is that for GPU as a whole?
d 17Ij THE WITNESS: Yes, since GPU has the only
[
i 18 ,t publicly traded stock to use the discounted cash-flow 19 ff approach, one has to look at GPU's stock price data, dividend a
20 data, as a proxy for the cost of capical for Met-Ed and 21 Penelee.
i 22 In the testimony I concluded that Met-Ed
~
23 is more risky than Penelee and it would be possible to: in e
24 4i my j udgment , it would be possible to assign a somewhat higher l i i l f
( 25 t cost to Met-Ed and a somewhat lower cost to Penelec.
.5
" McHRD AC)g & MARGMAL. INC. ~ 27 N. LOCKWtLLow AVC - HARfilS SURG . P A- 17112 l
\
Erigham-crosn 1721 '
y ,
i Q Dr. Bligham, initially . uaule like to refer
,,you te page 4 cf your Statenent llh
,k A Ye .4 . sir.
-te i Q Cn that pagE, sir, you m2ntion you are the i 4 [l h i 5jDirectorofthePublicUtilityResearchCenterat the i f
a 6o University of Florida, is that correct? i 5 . A Yes, it is. !
L .i n
Q And I believe in response to our Interrogatory 6h c
c.l No. 96, in Exhibit i of Attachment A to that response, you !
- p y show a listing of financial support for that center, is that l i;
,,jcorrect?
i 8 3, j A I believe it is. I don' t have a copy of the '-
13 j; Q You don't? ;
- 4 ]
U A No. Yee. l lh Q Calling your attention to that exhibit, 33 f i
16qDr. Brigham, insofar as the Public Utility Research Center's h
77 ; financial support is concerned, as I read that exhibit for
! E 3g the year 1972, over 90 percent of the funds made available to 39 !i that center were contributed by utilities, is that correct?
s A No, that is not correct.
20 F
Q And why not, sir?
3 1h Li A Because of the total which is $920,000 --
22 lai k
l 9 3j t a
Q No, I am sorry, sir, I am just referring to P
M_ p;,1972, the first year.
k A In the first year, that is correct.
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Brigham-cross 1222
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And in 1973 out of a total budget of l
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$'5> ' " *' '
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t 25$'5-i; 3 $ Correct? ,
9
, a i A Well, it is a matter of interpretation.
1 I w uld be more inclined to say that it was contributed 5
k 6 1, by ratepayers in the state of Florida becau::.e the Florida d
7 ] Public Service Commission had a policy decision to allow a :
6jthecompaniestomakecontributionsandchargetheminthe o rate base as an allowable cost, so in that sense the contributions were paid by the Florida consumers.
10 k
But technically you are correct, the payment l nl \
\
12 was made directly by the utilities. But, as I say, with the I i
13 lconcurrenceoftheFloridaPublicServiceCommission.
O Q But insofar as the 3ecision as to where this 14 j 15 ; m ney w uld go, did the utilities themselves make that i, decision? -
16 t
i A No.
37
~
t
' 18 y Q In ther words, did they determine who to 19 hire?
20 A No. They were explicitly not given that authority. It was retained by the university, the dispositio ,
21 i of the funds.
3 t
., 1 Q I am not referring to disposition of the 3 i i
- I am referring to the Research Center as the 24 ;! funds, sir.
Q 25 lrepsitoryofthefunds. That decision was left up to the j .
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$particular' utilities, is that correct? '
15 A To cor. tribute t? the Center" v
b Q Yes.
lO 3[ i li A It was left up~ to the utilities and the -
41 !
r,
} Ccomission at the inception of the Center supported it and i 1
I i I
, y told the companies they supported it and had a member of the ;
b:I :
( Executive Committee of the Center, and told the comoanier '
i
? i; !
O that the cost would be allowed as an operating 3xpense, an !
Sd ;
i above-the-line cost for the cot.panies. i 9h I
Q All right, Dr. Brigham, so ve can close this !
10 1 I 11 ;'
hoff,totheextentthat the companies involved did decide to j contribute funds to your Center, the Center of which you are i 12 i l 3 the Director, they had the ability to in essence pass those 13 h il j costs through to the ratepayers?
14 ;
A Yes, and I think they would not have made 15 ;,
O the contributions in support of the Center had the Commission 16 h I
not supported it.
17 Q Now, sir, as I track the contributions from 18 ll a the companies as it appears on Exhibit 1, generally speaking, 19 ?;
y
- but for 1979 there is a trend of increased contributions, is 20 l that correct?
21 i A Yes.
22 Q Would I also be correct, sir, that by and 23 i l large the contributions from the utilities for this time 24j 25
! span shown in the exhibit, i.e., 1972-1979, generally i
h 740MRDACH L MAF!Sil A L, !ltC. - 07 Nc LO CXWILLOW AVE. - HAR Ft!$SUf'O. P A. 17112
Brigham-cross 1224
/
t constitute more than half of the total funds available to 1 !
OtheCenter?
l 2h 2
d A Yes.
3 kn Q And, sir, what vould be your statement as to 41
{ the company contributions to the Cc.nter for the year 1980?
3! ~
{ A The company contributions in 1980, I believe,
, remained at the same level as 1979. I am not positive of i?
i that but I think that we decided to not seek an increase in 8 '
l 1980. i
? fI j Q I am confused, sir. What do you mean not 10 seek an increase?
11 ,
A Well, we decided to ask the companies for the same level of contributions as they had made in 1979,
d and I believe that was what was decided, and they in fact 24; made the same contributions that they made in 1979, i Q So, Dr. Brigham, this is not.necessarily a 16;
} type of situation -- I hate to use the phrase, arm's length ---
17 g this is not exactly a situation then where the Center is just 18 9 d there, z.nd if the companies happen to come in and contribute money, that is one thing, if they don't, that is another t
thing; r.pparently there is some type of interaction there where the Center sets an amount of money they would like to l
0see.
23 4 Perhaps you could just describe the procedure.
A, l
I A In 1972 when the Center was begun we developec
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Brigham-cross l'225
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I L* c budget and presented the budget tc the representatives 02 :
7 t
the companier cod the Florida PubLic Scrrice Ccmmission. and t
ll)
? ( said here is what ve want to do and here is acu much it s:culd ii 4 !
4l cost to do what we uant to do, and it was discussed and they i I
1 6 5; approved the budget. !
b 66 In subsequent years what we have done f
> r i
? [ basically is increase our budget, "he proposed enpendituree 4
8 [thatwehave,moreorlassto 'flect inflation and rising i Pi prices, more or less. !
i F
,i 10 ,j We have an Executive Cotzittae meeting with i 3
U 11 y representatives of companies and also the Florida Public l 5
12 i Service Commission and the budget is discossed and so far 13 it has been approved. ggg 14 Jf We don't present specific projects that we 15 ll' plan to do. We talk about the general areas that we plan to ,
r 160 study during the coming time. i i
17 h ff Also I should note that when we initially if N I 18 y set up the Public Utility Reser:ch Center we told the ;
N 19 l: companies and the Com=ission that we really did not want
, P D
20g to do it unless we had some continuity. So it was agreed 21 lintheminutesoftheinitialmeeting,itwasdiscussed il 22 l that the companies would make a commitment to every yetr 1
u 23 " sort of extend the contract for another five-year period c
24l; so we have e reasonable degree of assurance of continued l 0
25 ] financing for five years at least at the level of the priar I
fAOi4RS ACH & MARCHAL. INO. - 27 fa. LOOKY.tLLOW AVE.- H ARftl$guR G, PA. 171:2 -
Brigham-cross 1226 fi # i g
1 year, which makes it possible for us to make commitments !
2 ahead of time and be able to get peopic to do the kinds ct 3 ) research projects that we want cone. ;
j i 4y We feel that we operate very independently l C I 50ofthecompanies. WehaveaconferencecomingupinFebruaryl nl l l 6 l and we arte bringing in for the conference Chairman Charles !
i t 7j Curtis, t.he Chairman of the Federal Energy Regulatory II, 8l Commission,CharlesChiccetti, who was former Chairman of 9 the Wisconsin Commission, and Henry Rowlins, who is a member i r 10 of the Texas Commission, and they util be sort of primary 11 i Speakers at the conference. We tend I think to have a very E
12 balanced program.
13 Q Just so I understand this, Dr. Brigham, in V 1 14 5 your budgeting process, for instance, you say non-contributiops 15 are contributions from parties either the compan'es you are 16 discussing or the Public Service Commission of Ts.orida. Is
~
17 t are scme type of understanding with other parties as to 18 their contributions for each particular year?
19 MR. RUSSELL: If Your Honor please, I have 20 put up with this line of questioning to this point but I 21 think really in the context of the time frame in which we 22 q are working, and in the context of the testimony of this 23 I witness, this has reached the point of utter immateriality i
24 ! in cross-examination.
!O 25$
a It is minutiae of this witness' testimony.
l
! PACetRB ACH & f4AMSHA' INtJ, - 27 PL LOCitWILLOW AVf. - M 4f:M1SStJftG, PA. 17112
Brigham-cross 1327 -
1 E ,
l f.It has nothing*to do vith this vitness' testimony apart from ;
1 '. l t .
the fact that he ref;-rences this organleation and it is 2;
li dragging out mine ne that was produced in response to an i e
5 '. l
] interrogatory. '
/. e I u f i I think it is immaterial for the purposes of l 5h j
, ij this case. ,
-y i MR. BURGRAFF: Uell, Your Hor,or, I would 7n) o i
I ifdisagree if I might make a brief statement. I am cimply !
8 it i lj l j trying to lay a foundation for further questioning of Dr. l 9;: ;
Ioh'Brigham.
n :
f I think we should have the ability to loch j
_s,_ ;
3 at the Center that he directs, at least as far as where his 12
,,iifunds come from, and I don't plan on staying on this too much longer. I am simply trying to understand -- llh 14;h, lj THE ADMINISTRATIVE LAW JUDGE: We will over-15 h ,
. I 16l [j rule the objection provided that you conclude your examinacion I in that field quite promptly. It is getting a little far is i
! afield.
18 1
! MR. BURGRAFF: Can I have the question 19 g 20;l repeated,please?
1 21 l; (The following was read by the reporter:
t 22 p Question: Just so I understand this, Dr.
d 23h Brigham, in your budgeting process, for instance, p
24 1 you say non-contributions are contributions from ggg 25 i o
!L men esAcx e. we nsxA:.. INC. - 27 Ne LOCKW:LL OW Avt'. ~ H AR F'iS BUP G. P A. 17112
Brigham-cross 1228 i e i e
f .
parties aither the companies you are discussing
.g 4
r the Public Service Commiscica of Florida. !
(]) 2 s i Is there some type of understanding with other
- 3) j
, parties as to their contributions for each u
4 3g particular year?)
1 6e '
i THE WITNESS: R , the cther funds that se .
Y t I i 7 ; have gottee we show c fairly small amount from other, a ;
a f 8i i l total of about $12,000 it looks like out of close to a millich i
nj ;
- l has come from -- we have put on some conferences and we have s
10 ) charged people the out-of-pocket costs that we incur for ;
I 11 l luncheons and that kind of thing. .
x i*
- 23 1
The other types of funds that we have gotten,-
3
(')s -
, other than from the ccmpanies, have primarily been research 143 grants.
1: 3
-~ p For example, $168,000 shows from the Division-J 16lof Sponsoring Research. That actually is a grant from the 17 I 7
U.S. Department of Energy through the Florida Public Service 18 *i j Commission that came into the university and the Division of i
194 5 Sponsoring Research, which is an administrative organization, 90
~
I but that was on a particular project that the Department of 21 y Energy had requested a study to be done in that area'.
I 22 h The other grants, otbar funds tend to be of f
23 k the same nature where the State Legislature, for example, k
() 34[hasfundedinfiveoftheeightyearstheStateLegislature
'5E has funded studies for the Board of Regents of the University
~
g 17312 Mc HPI S ACM f. SaAR ENAL, LNC. - 27 N.- LOCat WiLL OW P YE. " H A9RISSURG. PA.
V
Brigham-cross 1229 M /
< l' t
4 of Florida. The utility and public service contributions ;
!. I hrve been non-proj ects specifics 11. 7 Y
.c l
h 2 i( BY MR. BURGRAFF:
Q One inst question in this regard, Dr. Brigham.f ff n
4 As I tctal the contributions for the peried 1972 through 1579 cL .
3
, i from utilities I come up with cppror.imately c half r mil'icn l 0k i i dollars. Does that sound familicr? .
7E i A I would accept that. !
8[ n n
b Q Subj ec t to check?
ou
' fi A Yes, sir.
f i! Q Now, sir, have you ever testified on behalf 11 4 L
!! of any of the companies listed in Exhibit 1 of Attachment A I 12 !! j 4
,3 L, A
in response to our Interrogatory No. 96? f
! A We have an agreement that was put in at the 14 .i I
j' time that we starttJ the Public Utility Research Center that 15 f d nobody associated with the Public Utility Research Center j 16 h 0 will testify at the direct requent of a company.
17 b I have and other people at the university 18 [
!! have testified, but the Commission has requested the testimonfr.
19 4 a
! I personally testified twice. Once the 20h .
Commission wanted someone to testify in a Bell Telephone
! case about the proj ected growth rate in the st. ate and the 22 0, 0 need for telecommunications services, and I testified 23!:
L h sponsored by Bell, but I did not receive any compensation 24s 2h
' for it.
llI MOHREACH L f4 ARSH AL, tHC. - 27 fC LOOKY'!LLOW EVE. - H A M 8HS B U P.G. PA. 17112 s
Brigham-cross 1230
, e i
$ ' l I testified once in a Florida Pouer 1,h Corporation case uhere a number cf public vi:nesses had li come in and made suggestions for alternatives to a rate '
3 ,\
I increase and the Commission wanted somebody :o essentially i 4 4 i a
rebut those positions because most of them were unreasonable.'
~\ r I testified in that case. Again it was as j 6[5 .
II a reoresentative of the Public Service Commission znd not 7it i i
I for compensation.
8 i 1 1 did and other people have testified when i 9 i 10 ;r we have been requested by the Commission. -
l: i That is in the jurisdiction of Florida, is Q
. 11S.
i y that correct?
12 t r A Yes , tha t is correct.
] 13 [.
I Now outside of Florida have you restified I
Q 14 J
1 at 15q[ on behalf of any of the companies listed on Exhibit .
! ythecompanics' behest?
l 16 l l A Not at the request of any of those specific 17 l l companies. I have testified for Bell Systems subsidiarica 18d but not at the recuest of the Southern Bell Florida
^
19
! operations.
20 4 Q But you have testified on behalf of Southern 21 f Bell generally in other jurisdictions?
22 R
] A I have, yes.
, 23
- l ! Q Am I correct, sir, that was with compensation?
. 24 q
A Yes.
I raownexcw c uanswat. inc. - =7 re. toenwit'ow vt. - w^rmieaur c. ra- 37'i2 l .. .
Brigham-cross : 1231 .
( < .
1 1 e
1( Q In response to our Interrogetory No. 86, !
2 f in particuler Attachment A. thereto--
h 36 MR. BURGRAFF: Could we 3o off-the-record
'f ;
(An off-the-record discussion was had.)
i 5
c THE ADMINISTRATIVE IAW JUDG3: Back on-thet i .
0hrecord.c 4 ,
'b MR. RUSSELL: The Consumer Advocate hcs 8
l posed a rather astounding number of interrogatories, over 100 -
- c. i
~j in the rate of return area alone. We had responded to the !
k i 1C f; first 50-some at an earlier point. The last number of these 11 > we got responses together earlier this week to m:ke avai'.able' 4
12 lj for inspection and copying and the Consumer Advocate had 13l4them .1 for inspection and delivered them to me last night, so g 14 ! I have cham here at the table if anyone wants to take a look I
15 ,l at them. I have them here. This is the only set I have. !
16 lj Apparently the Consumer Advocate has run some copies of them ll .
17 tj that they have in their possession.
S 10 ! THE ADMINISTRATIVE IAV JUDG5: Very well.
1 19 f BY MR. BURGRAFF:
9 20 Do you have that, Mr. , Brigham?
Q 21l F A Yes, I do.
22! Q As I look at Attachment A, Dr. Brigham, I!
23 !! since 1972 you have filed testimony in approximately 38 cases ,
H 24 is that correct?
g 253,, A I didn't count them, but yes, that is corrset.
eneans Acw a sc.nseAr anc. - 27 n s.ect:wu. cow Avt. - udsaistuas. PA. witz
. . Brigha:n c;c33 1232 i f 1
? I .
l 1h Q And, sir, if I might ask, in these 38 K f O 2 s casee from 1972, me meny times heve yo, fi;ed testimom,or
? tes tified on behalf of a party other than a 2tility?
t t
4 A Practically all for utilities. Probably 5 all for utilities, The only one that would be questionable !
D i 6 would be in the 1974 for Florida Powar Corporation. It we.s Y really through the request of the Commiasion, but generally :
i SfspeakingIhavetestifiedforcompanies. !
I t
- e f
j Q In returning to page four of your Statement
-i ,
10 H if I could Dr. Brigham, I was intrigued by your statement l i i 11 -
that in the first answer it states: "The Center receives i 4 :
12 h financial support, data and suggestions for research projects I i 13 ! from cortain groups", and that includes the Florida Consumsr 14- l Counsel, is that correct?
l i
l 15 j! A That is correct, and it should have read 16 j *'the Center receives financial support data and/or suggestions" l
17 because we have not received any financial support from the 18! Florida Consumer Council.
LI 19 i What kind of suggestions, if I may ask, Q
?
20; has the Florida Consumer Council presented to the Center?
21 A When the Florida Consumer Council was 22 ; first created, and I forget exactly when that was, but it 4
23 l was somewhere back probably around 1973 or1974, somewhere in I
.R 24 l that v .cinity, the first Consumer Counsel, Mr. Fred Carl ju 25 h'. ~ ccme down to the University and we spent some time talking l l f40NRE ACH & B1AR$HAL. tNC. - 2? H. LSCKWTLLOW AVE. - MARR!$8U.% PA. 17.112 i
l
Brigham crans 1233 , o g .
Ie uith him inst about utility regulstion in geaerci and I have 2 subsequently talked with other people. lll t
3[ I must say that I hcVe probsbly talked lesr U i 4,1 with the Consumer Counsel than other people essocistad with ti,te E .
5 i Public Utility Research Center. Since I deal primarily with ,!
- i I 6 l the rate of return, cost of ecpital as opposed to economicc,
? [ which would include rate structure and thtt rype thing, I S[{havenot had personally that much contact with the Consumer 9 [ Counsel. Other people involved with *he Fublic Utili*y !
10 h.,! Research Center hcve done more than I have. l li 11,j Q Well, sir, so we can wrap this up, as I 1
12 g understand what you are saying is to paraphrase, and correct I h I 13 me if I am wrong, insofar as one is considering the area of llg 14 [ rate of return and cost of capital, you cannot recall any
)
15 q particular suggestions for research projects that the Couasel, l
16 !! made of your organization? j A i 0
l 17 C A I cannot recall any particular one, no. i d !
18.4 Q Would that also apply to any data that t
i 19 [l tay have been provided or may not have been provided?
t 20 ! A I don't believe the Consumer Counsel has h
1 21 j very much data per se. I meant to my knowledge they don't l
22j collect it. The companies do and the Commission does.
23 yE Q I believe, sir, on pages 18 and 19 of your L
24 Statement No. H under your discussion of the TMI-1 accident, ggg a
25 j you make the statement that all of this increased the perceived I f
1
Brigham cross 1230
- e 1
- . l 1 r riskiness of any utility with a nuclocr uniu. Obviousi: the .
r
) 2 risk effects on GPU were rar greater tacn :he other utilities.
I A I recall it. I don't see it specificc11y, 4 .but I recall the statement. j 5 ,
Q I am s orrv . It is the last line on pcge lE 6 carrying over to two lines in page 19. ,
? .
A Yes.
I Sl Q And is it your opinion, sir, that the j 9 accident has increased investors' perception of risk . :.d l
10 j thereby contributing to the increased cast of capital for ;
11 ! utilities in general? ;
f t ,
12 A Yes. -
13 .i Q Drs Brigham, do you have available your j f~S J l 14 ' response to our Question No. 94?
15, MR. RUSSELL: Are you talking about cle i
16 Attachment A cnd B?
17 MR. B'JRGRAFF: No, j ust the nara tive . !
18 ,
THE WITNESS: Yes.
19 BY MR. BURGRAFF:
20 Q Now on the second page of that narative,
! 21 Dr. Brigham, I believe you state that or you mention that 22 you appeared on a panel which discussed the effects of THI-1 23 and the cost of capital for public utilities, is that correct'?j I
ips 24 A Yes, it is. l
!kl ; i 25 i Q And it was in April 1980 in Savannah, i 1 1 uownoxew a uanswxt, inc. evittow Ave. ~ wanetzssuria. PA. 17812 '
l l
l I
mn Y' L
Brigham-cross 1235 . .
ii e !
[ .
i 1 { Georgia?
2 A Yes, it was, g 3fe Q Dr. Brigham, has the Pu>1ic Utility !
4 t lResearchCenter,of which you are the Director, has that j
5 .ii body issued any working papers on the subject of the effects '
L 2
C f of TMI on a rish perception to the investor?
4 7h .
A One of the fac.91ty members of the j a
S University, Professor Pettway, has done some work in that 9 ,! area. I don't believe it was a Public Utility Research i p
il I 10 3 Center paper per se, but the Public Utility Research Center 4
11 jlt did support him. My recollection is that is the only one il 12 { that has been done by anybody at Florida on TMI per se.
~'
13 f n
Q Dr. Brighamj I have a paper identified as 14 $ working paper of Public Utility Research Center. It is e
t 15 titled "The Effects of the Three Mile Island nuclear accidenti e
16 upon the risky perception of the investors in public utility i
17 shares" by Richard Pettway.
i 18 Underneath it it states "the College of 19 Business Administration, University of Florida, Gainesville, 20 h Florida 32611".
1
! 21 , Is this the document that we are ! referring 1
l 22 f to?
i 23!J A That is what I was referring to. I didn't
! i 24 ) recall what it had said, but he put one of the covers on it l
25 [ and called it a working paper. That is what I am referring e
! MOHREACH & MARSH AL. WC. - 27 N. LOCKWILLOW AVE, - H AnftlS9URG, PA. 17112
. . Brigham-cross 1235
- /
i < .
I i to, yes, sir.
O 2y 4
a 1 .ou1d 11xe te, if 1 cou1d or. Brigamm, 3 l read you the last paragraph on Mr. Pettesy's section entitled 4 j "ree' tits of portfolio study" and ask you fo r your opinions 5' thereon, 6
l MR. RUSS%L: Well, I think it would be l
- , jbl appropriate to show the document to the uitness first of all.l 8l MR. BURGRAFF: Yes, I apologize, 9 Mr. Russell.
10 BY MR. BURGRAFF:
t 11 ) Q The paragraph reads, Doctor, in final l 12 summary "due to lack of a long period of stability prior to 13 the Three Mile Island shock, it was harder to analyze the p
14 effects of the 7MI accident than to analyze the oil embargo 15 -
or the Consolidated Edison dividend omission shocks, yet i
16; the three different methodologies employed on a portfolio 17 of weekly returns on flow-through electric utilities from 18 1971 through 1979 each found that the TMI-l nuclear accident
'9i
' ~
did not cause a major or significant shif t in investor 20 risk perceptions."
21 I am sorry, TMI-1 nuclear accident.
22 : A Do you want me to comment on that?
I 23 l Yes. I am formulating the question.
Q I
gm 24 j Ferhaps the question should be, sir, do you agree with 25 Mr. Fettway and to the extent that you dcn't agree with FJOMRSACM t. M AR SHAL. INC. - 27 N.1;eCKWiLLOYI AVE - H ARRISGWAG. PA. 17112 l
w szsn p: 0 $
f f 1 I(Mr.Pettway,whynot?
2 r
A No, sir. I do not agree with Dr. Pettway g
I iq and the recen that I don't agree with it is th t his m2thod- j 4 ( ology, he ec: ployed a procedure called the capital asset i
5 [ pricing model using historic data and in ny judgment, the !
i 6 ' capital asset pricing model has been deconstrated to be
? ( not applicable for utility companies because the co:rpanies I capital.
8ksimplydonotmeetthestringertassumptionsthat the/ asset Efpricingmodelrequires,andIthinkthat the results that he n
10 ' got are simply random happenstance routes and they really l.'
11 ] don't say very much at all about what might or not have been k
12 happening to the cost of capitsi, the riskiness that is 13 p j perceived by investors of utilitiec. I g
14 I think there is better evidence than 15 f Dr. Pettway's study. I think his study is incorrect.
9 1 6 ii Q Dr. Brigha:r, by your answer I am assuming 4
17 0l: that you are familiar with this work paper? -
9 18 .j A I have read that working paper some tine 19 b l
q back and I have talked to him quite a bit about it.
20 And in this document perhaps you could Q -
21 f i point out to me where it states that the capital asset pricing 22 lmodelisusedasyousuggest.
6 l
23 A I am not sure if I could point out where E
The method-i 24 9 it is crated in the article, but he does use it.
l i 25 l ology that he follows is that he uses the capital asset pricipg L i ue%uen t mww_. me. - n n. tecewu.i.ow ave. - HARRL? SURG. PA. 17112
. . Brighaa-cross 1233
/
1 l motbodelogy to get an expected rate of return for the stocks i
()
E 2 E and then he compcres those expected rates of return with tha l u
i I 3 i actual rates of return and develops something called l l
o l; 4 .0 accumulative residual and that accumulated residual is a 5; primary variable that he focuses on and it is fundamentally 6 f dependant on the capital asset pricing model being correct. l
[
?j Q Well perhaps I could just show you the j 8 document and you could simply point to'me where the capital 90 asset pricing model is. l
!i 10 $ A All right. I will have to look at it for 1 i
1 .
11 j a minute. :
i i 12 'i Q Sure. ,!
l the !
13 hl A Well, one element of/ capital asset pricing 14 model was the beta co-efficient and if you look at page 19, 15 -
table 1, you will see that 'he shows on here the betas so that 16! l 1s one piece that it would be apparent that he is using che 0
l 17 i capital asset pricing model. ,
t, t
[
j 18 i' Q Well betas don't necessarily have to be J
i 19 used if you are using that model? One can employ betas in 20'l h different analyses, is that correct?
21l A .W ell, the beta, they are discussing here on page 18 beta estimmte, beta co-efficients makes sense only 22 ll I
23 in a capital asset pricing model framework. Betas are a 5
24 hl part of the capital asset pricing model and betas were C l 25 k originated cad created by Professor Sharp of Stauford in an MOWRE ACH & M AR SHAl INC. - 27 N. t.0CKWu.I.OW AVE. - H AAAtS13tmG, PA. 17112 -
I I
Brigham-cross 1239 - -
t , 1 I l article where he set forth the ccpital acaet pricing medel. l f
2 If the capital asset pricing model doesn' t hold, then ona f$
3 ; could questica what the betas se:ually mean. ;
- j. !
4[t Q Well are you suggesting, Dr. Brigham, 5 I because this paper employs betas thct it must be a capitsi !
I 6 . asset pricing model?
7E i. I am suggesting it is a capital csset ;
i V
6 pricing model paper and I talked to Dr. Pettway on numarcus -
9I times about the whole approach. l 10 f Q Well perhaps you could point to me where
(
11 t Dr. Pettway states it is a capital asset pricing codel.
i 12 h; .
A Well I am not sure he would state it i 13 j, because it would be so obvious for the people that it was g i
1+ $l. n intended for, an acedemic audience. The paper was actually 15 E presented, if I am not mistaken, for the Western Finance ;
n 16 ll Associstion meetings . I
'l 17 l' Well, okay, on page 4 when he is describinh 18 l his methodology, he says: "the market methodology first- l 0 i 19hsuggestedbySharp". Sharp Reference No. 9 is titled "subtiffed li 20 t ij model for portfolio analysis" and immdiately under that is - i 21 l that was a 1963 article--and immediately under that there is 1
22 j en article by Sharp entitled " Capital asset prices, theory, 23 Np market, equilibrium- " ;
k 24 Q That is footnote 10, isn' t it?
g 25[1 A Reference 10 and they are together by the 3'
MOHRD ACH 0 f t A RSH A1. INC. .~7 Ne LCCICWIL2.0% AVO ~ HARRISBURC. PA. 37112
- n,
, , Brighem-cross., 1240 n i f g < .
- t 1jsameauthor,ProfessorShcrp,buthedoessay,asIindicated, f
2 the market model which is a capital csset pricing model 2irst -
3:f suggested by Sharp and later erpanded by Sharp in 10.
4l, The other reference that I referred to by l; 5 Litner and others assert that and then he gives the capital f
6 l asset pricing model equation, so it is just obvious that that 1
7v is a capital asset pricing model. That 3s the capitc1 asset :
E ;
e 4
pricing model equat2.on. I p l Q Page 4? -
l J
10 .2 A Page 4, right. I am sure I could poir.t to!
!! l 11 h numerous pisces in here. l h ;
R !
12 g Q Dr. Brigham, what written working papers ;
4 i
^
12 !i or study would you feel would be the mest effective or give i O ;
14 j the best results as to the effects of the accident at Three 155q Mile Island upon risk perceptions that investors in public 16 ! utilities share?
I i
17 j A Well, I have not done a working paper on
- l >
IS j it. The only one as iI indicated earlier that addressed ]1 l 11 19 # that issue was Dr. Pettway's and I think his methodology was h
2O [ incorrect, so I don't think there is a Public Utility 21 Research Center working paper that deals with it.
I 22l Q I am not limiting myself to the Center. I 23 )I am talking about any written working paper or study.
E f5 24f A Well, I think, number one, that if you are V !!
- 25 I trying to focus and trying to get statistical information on f>
MC*4R E ACJ4 ta f.l AR SF AL, IN O. - 27 N. LOCKV/tLLO'.? , VT - HARRIS 5tJRC. PA. 1711*
i
Brigham-cross 1241 , ,
s ', i C e !
I l the effects of the Three Mile Island accident on the cosc of 2 ! capitol, I think it 10 alcost en icpossible job because chsre c
g 2 is so many factors thct have occurrad about the ssme tic.u..
I 4 the rising fuel cost, the rising interest rate, increased 5ih regulctory lag. All those things merged in or meshed in with 6 j; the Three Mile Island accident, so if you look at statistics ,
a t
7 economic statistics simply are not susceptible to separating 6 ! the effects of one particular variable uhan a lot of things 9 are happening simultaneously.
10 1 think that a much better way to approach a
it is to use your common sense and common sense would suggest 11lc 12 !! that the fact that that type accident now that we know it carj k
c 4 1
13 cccur, the consequences from that from the standpoint of a '
g 14 s utility stock, you can have a utility stock that goes from 1
15 j S8 to $4 and three-eighths at this point. That tells m2, 3 1
3 '
16 ; and I think it tells most people who use reason that tha t i l i 17 g has got to have increased the perceived riskiness of the j
.g j4 utility industry.
2 i i
19 Also, if you loch at things coming out 20 in the press like the Wall Street Journal of November 20th, I a l
21!i 1980 on page 56, it had a four colu=n article dealing with y
5 22 1 it. The title of it was "some investors shown in nuclear y 11 i
-3 4 power utilities jeopardized funds to build nuclear plants" k
24 l The article goes on to talk about the slow build-up.
g 25.1 e
M C HR E AC >i L M CI S H AL. t ri c. - 37 N. LO citWu.1.CY.' AVE. - r4 4 R.H S B UTL3. PA. 17132
Brigham-cross 1242 1 e '
i ba. BURGRAFF: Excuse me, I have no problems ,
Ij ; I
! with Dr. Brigham referring to an article ac to the existence
() 2-However, since it is hearsay I would object :
j of the article.
3 i :
1 i i to any averments being made as to the truth of what is in i
+ i I that article.
5 j THE ADMINISTRATIVE LAW JUDGE: It is not ;
ea ,
N responsive to the question. The objection is sustained, i l 7 ifa 1
,1 MP. BURGRAFF: Thank you.
8 i 1
4 BY MR. BURGRAFF: -
9 t.
I Q Dr. Brigham, on page 24 of your Statement H, i .
10 :
,, lines 10 and 11, I believe, you state that investors recognize l 11 Q that every investment, except short-term Treasury securities i
g:, ,
^ l involves some risks, is thnt correct?
(_) A Yes.
14 i Q In your Appendix A, page 11, lines 1 through 3 you indicate that the constant maturity long-term U.S.
16 t
(
l ,e ;! Treasury Bond is the best choice of a riskiess rate, is 18 lthatcorrect?
A Yes.
9 888 , n Page 30, line 7 of your 20 Statement H you indicate that 3.S. Treasury Bonds have 41 :
I 22 ! zero risk, is that ' correct?
a
, A Zero default risk. They have what is 23 t called an interest rate risk.
4 r
- ) 4 j Q Given your answer on page 24 and your answer 25 j t
IJ cHP.SACM & IAAFtSHA! INC. - 27 N. LOC:', WILLOW / VE. - M A R.'*!SS UR G. PA. 17112 -
Brigfrm-cros s 1243 l < .
3 on page 11 in Appendin A,1 am a little cer. fused as co t,
which U.S. Treasu y securities one should use when trying ,
g; to approximate something close to a zero risk.
=s 1 A That issue has been debated quite a bit, and 4
t '
3;n as I indicated in one of the data response requests to f.
6 ] interrogatories we have looked at it and ccaeluded that for l n
,,fpurposesofapplyingtheriskpremiummethodthelong-term f u .
il I Treasury Bond rate is the best Treasury security rate to g g! ! i eyuse,primarilybecausealthoughtheTreasuryBonddoes n i 10 f entail some risk, this interest rate risk that I mention, !
.i .
g it does have a maturity that is more similar to stocks than j 6 t 12' q a short-term rate like the prime rate or the Treasury bill ,!
i
,,,krateorsomethinglikethat. '
W G gg In the studies that I have done and also
,, institutional investors, money managers, that deal with that
_ s ;.
16 f,, kind of thing, the general conclusion is that it is better 6
17 [1 to compare stock investments with long-term bond investments than it is to compare stock investments with short-term 13 l
1 l 19 l m ney market security investments.
The difficulty with using short-term rates 20 21 g y in a risk premium study is that short rates are just so g extremely volatile. We had a situation this year that n
2'., y demons trates that where the prime rate, for example, has a
b
,- _ k increased five percentage points within a very short order, N
25 p 1 ng-term rates have not gone up nearly that much, and equity n
l L- MOHRSACH & MARSHAL. INC. - 27 N. LOCKWILLOW A V E . "" H A R R!S hU R G. PA. ' 17112 l
l
Brighara-cross 1244
/
!! o .
7 i
capital costs would be more closely correlated with long rates 7
k j than with short rates.
There is no perfect set of data to use, but c
the choice is between long Treasuries and short Treasuri2s, 4
5 and given that choice, long Treasuries are a better choice' l
f r the reasons set forth in one of the data request respor,ses.
6j s
,j Q Now if we could, Dr. Brigham, I would like t
.g to turn to your risk premium analysis, if I could, sir.
9, A Appendix A? ;
Q Yes. You state on page 31 of your statement 10 ,
that Appendix A represents a recently completed risk premium study at the Center, is that correct?
g A Yes.
13 ,
Q On page 32 of your statement, the first full p
answer on that page you state the average risk premium for the large New York Stock Exchange e spanies is approximately 4 16 6 percent. For the least risky companies, the. risk premiura
-t is 4.5 to 5 percent, while the most risky of the larger yg 79
' companies has a risk premium in the 7 to 7.5 percent range, is that correct?
20 A Yes.
g Q Am I correct, Dr. Brigham, that that range l ,3sg you discuss on page 32 of your Statement H is basically
~
j r derived in your Appendix A and-shown on page 6 of that 4
O Appendix, where the five risk groups are set out and risk 25 I fACHTtB ACH & M ARSHAL. INC. - 27 N. LOCKWILLOW AYE. - HARRIS 8URG. PA. 47312
Brigham-cross 1245
- i. i t
, ; premiums are shown over U.S. Treacury Bonds and over doubl:--I.
i i i corporate bonds?
2 ;
(g) a A Not really, no. On page 6 1 do give some a[
u
, h ranges that are more or less judgmental, based on discussions
'O
._ d that I have had over time with security analysts, but the oR o ;; 6 percent rish premium average in tha range from 4.5 to 5 :ndl a !
,, 'l 7 to 7.5 is based primarily on the additicnal material in i
8 the Appendix going on for thirty odd pages, more so than on 6
1 g ' page 6.
I n,i. Q Perhaps you could flesh that answer out for i
~~d :
g j me so I understand exactly. j i
, A Let me suggest we look at page 28 which is, n kshowsagraphofriskpremiumsforindustrialsandelectrics E
4g and the latest information that we have shows a risk premium i
h of a little over 6 percent for both the industrials and for 15 F i
16 li the electrics.
Cver the last half of the decade of the 7
1.
IS g
- 1970's the risk premium had been fluctuating from about 5 to 7 percent, generally speaking, and that would be for 19 h:
l ,0 ,.
an average company, i
O 21s.>
r There is some indication from that same i exhibit that risk premiums seem to fluctuate a bit over time 22 t P
l ,o
~ ..
p and we have no way of statistically quantifying the extent ,
- i. t 24 [ of the error, but I know that the data is net measuring risk '
r
. , . -, , ;. premiums exactly and precisely, and in my judgment we probably g
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Brigham-cross 1246 I < I i are talking ab'out a risk premiuri error of perhaps a half a l
, percentage point for the average company, conceivably as much i
_ l as_a whole percentage point.
}
! Then in some other work that is not set forth 4
in the testimony that I had done prior to that, actually Mr. Chome and I had done an earlier paper, we concluded that j 6
] risk premium ranges for the least risky of the large co:cpanied t
l g are probably in the neighborhood of a point to a point and i 1 g
/ a half lower than the average, and for the most risky of those companies a point to a point and a half higher than l t
the average.
11 So in making the statement that I made in g ~g the testimony I was relying on my past experience.
U Q What paper was that, sir?
I A I can't recall the exact paper but what we have done over time, going back about two years, we have w
been working on the matter of estimating risk ~ premiums.
l The first paper that we had was presented 18 g at a conference in the Netherlands, and was published in a book that just came out a few weeks ago.
20e 1
! As I say, that was done about two years ago.
Then over time we have been trying to get additional and better estimates of the risk premium and there have been several versions of it. That was the first draft. The
/N# 24 Appendix A is the latest and most recent version of the paper .
MOHRBACH Sc MARSHAL. INC. - 27 N.- LOOKWILLOW t.VE. ~ H AR?tlS8 URG. PA. 17112
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< {
l .
Appendin A is a refine. ment of the earher 3
p ;
-k !
! work that we did two years ago and there have been several b
versions, I believe, either one or two, in h
versi ns, tu 3
3 l betueen the first and the current one.
5!
k Q Let me understand this. The earlier paper, t
6 y u don't recall the title of it, or I assume it exists but i a !
7 h you are saying in essence it was incorporated into a recent n .
g!jbook,isthatcorrect? I i
- g ] A That is correct, yes. ,
ll }
3 p 't Q And now yoc are saying Appendix A is a :
i 1 1 further refinement of tnat earlier work, is that correct?
g l A That is correct. The way most people do 13 [
13 ( research is you have some topic that you want to investigate 14 and you do something with it and you reach conclusions, then g you write the results up and you present it and have it n
discussed. In this case it was discussed by a number of -
16 7
academicians, U.S. and European finance people.
7 i
Then when you finish that you get some 18 1
19 j ideas from those people, then you go on and see if you can 20 get some additional data, try soms additional tests.
l 1
We have been doing that on an ongoing basis.
21 l
Appendix A represents the latest version of the research 22 I-23 ! that we have done.
I i The titles are generally speaking pretty
~4 a
! ,, i
.5, much the same. It always has something about risk premiums i
F.OHRBACH (2 14ARSHAL. tNC. - 27 N. LOCKWILLCW A VE. - M A RR!seURG. PA. 17112
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I and common stock.
}
O 2; o raeok you, sir- sow es 1 reea ^99emat= ^
' you seem to be saying from your discussions with portfolio managers and from your judgment you have come up with a 4
5 five tier ranking of stock risk group.
In discussing Figure 5 and apparently your 6 (;
7g11earlier work you say you have concluded from your earlier 3 work that the same type of risk ranking from low to high 9 would be to fluctuate from 1 to 1.5, either above or below 10 a 6 percent range.
g f I guess my question, Dr. Brigham, is how did 12 y u arrive at that conclusion in your prior work, which apparently you say exists on Figure 5, or the 6 percent on Q
13 p 5, but the classification was a conclusion developed earlier.
l A If you read straight through the Appendix 15 16 and you think of it as a development of a concept and idea --
17 and it really almost follows a chronological development both 18 in my own thinking and also in academic thinking generally --
19 eight, ten years ago'there really was no quantative informa-20 ! tion on the risk premium and risk premiums were discussed 21 in textbooks and they were discussed in various places in the academic literature but it was always in the form that 22(
l 23 , is given on page 6 where somebody like myself or somebody 1
., .1 else would have gone to some portfolio managers and talked
~4
(-)s I i 25 l to them about what they do and they would have said we rank l l2! wesas4:n mansart, inc. - av ne toexwittow ave. - wanaiseuno. PA. i7 in l
t
Brigham-cross 1249 i <
them in five different risk classes, five A
I{ stocks and we put
, f, different groups , or they could have said seven or three, !
- [ r h j but five is the most frequently used.
R l Then they alway: tell you -- which is again entremely logical -- that since they are managing long-term lportfoliossuchaspensionplanstheyaremakingcomparisons I
i l
,ifbetweenstocksandbonds,andtheyrecognizethatofthese ej flong-termassets,U.S.Treasurysecuritieswouldbethe 8a I. I 4 least risky type asset they could buy, type long-term asset 9 ,lj i 10 p jl thev could buv, and there ought to be some differential, l 11yl) some increased spread or risk premium on stocks over bonds:
!i because of the risk differential.
12 1
- d If you talk to people they give you information,
,3 1 ll N d I am sure if you talk to different ones you get somewhat '
14 $ an I different information.
15 j .
But I just put this in the working paper .co 16 n[
indicate a method of thinking. And then if you go on to 17 i 18 ,
jpage8youwouldseethatIputinasteptowardquantifying 8
l .,
8 it by Charles Benore of Paine Webber where he tried to make 19 1 l -- he has tried to quantify this and sent out questionnaires 20 !
l ! to actually portfolio managers and asked them what risk l 21 !
I i premium they use.
22 l Now he was looking at the risk premium over j 23 !
l b corporate bonds rather than the risk premium over Treasury 24lj Bonds but it is the same sort of concept.
i 25 i F
MCe4RO ACH & ht AR EPAL. !?(c. - 27 NJ LSCKWtLLCW A VE. - HA 9 n LS B U R G. P A. 17112
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, 5 So the first one, the one on page 6 deals
'E l g just with the concept and its intuitive information, then
, on page 8 the survey information, and then from there on in 4, the balance of the paper it discusses attempts to quanti.ty 3 ,the risk premiums that Mr. Shome and I have made, and then l
g ; also we compare it with the work done by Professor 191kiel ll 7 of Princeton.
g Q I understand the quantification of the risk l'
9 ' premium, which as you have shown in Figure 5 in your work 10 shakes out at around 6 percent. What I am interested in, 11 ' Dr. Brigham, is how you arrived at your risk differential 12 numbers to be applied to different groups, in other words, 13 your 1 to 1.5 swing in either direction.
O Perhaps you can just tell me how you arrived 14 15 at that.
16, A One method, of course, would be to talk to 37 people, pension fund trustees and managers of portfolios.
18 That.is one procedure and that is what is basically discussed 19 ' back on page 6.
20 The spread there would be -- is consistent 21 with that --
at the high end it gets a little higher than 22 those numbers that I used --
l 23 O Did you do that, sir?
y A Did I talk with people? Yes.
b~ And that is a part of your judgmental 1 to 25 Q 1
tdOHRBACH 2: MARSHAL. INC. ~ 27 He I;@Ct WILLCW AVE. - H ARrtlSet/RC. PA. 17112
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,Y; r .
C1.5 cwing either way off of o percent? I t l g A Pcrt of it, yes. Then we also applied the g
, gcapitalasset pricing model to see uhat sort of results we p
.i!would 4 i; get there.
I Again, the 1 to 1.5 percent differential _s l 5 l 6 j suggested within the ballpark that the capital asset pricing l
0 i e
- udel would give you. l
( ;
l l g Then I have also loched at what some of the 1 l !
I g institutional investors that tend to quantify their results i s J G ! reasonably well, with the best example being Wells Fargo, and l ,
l !
3j Wells Fargo uses a version of the capital asset pricing model
'2 and the numbers that they get are consistent with the numbers l
p 73 ! chat I got.
That is generally it. You can' t prove it.
O l p, s not something that you can weigh or measure the l 15t It 1 ?
16' height of. You can use some data to help get a better, 1
m re inf rmed judgment, but it is a 'udgmental conclusion. -
17 18 For example, there is no data that would gg suggest that the risk premium at .' east for this type company 1
20[wuldbebiggerthan,orthespreadovertheaveragewould l
37 ;be bigger than say three percentage points. I have not seen i
g any data that would sn; gest that nor have I seen any data l 23 that would sug' gest that it could be lower than two, two and
'P g a half percentage points below the average.
But it is judgment within that range.
O l 25 :
l 0 MCHRDACH & M AftSH AL. INC. - 27 Me I;eCXVnLLOW AVE. - H AReiselfRG. PA. 17112
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/
) The work you did with the capital ascet
, Q i.
y pricing model, is that in a working paper form or what form l k !
g has that taken?
3 ,,
i A It was contained in one of the versions -- i e
i yes, it was described in one of the papers.
5, I
Q Which paper would that be and which version, 0 d 3 1
y if I might ask?
l 7j F A I can't recall whethar that was in the one 8l I
that we presented in the Netherlands or not. We used it 9! i.-
Il before we got the Value Line data. 7nen we had the Value 10 4 i
11 l Line data, which is described in Appendix A, that in my g
! judgment is the best risk premium that we can get, and now 12 j that we have that I am less inclined to go back and use O
v
~~
the capital asset pricing model and use the other types of 14 .
d things.
l 15 ll i I am more inclined to rely on the value Line I 16 l
data of risk premiums that we just simply did not have earliep 2.7 n .,
! and now that we have it I have tended to drop out references 18 l
to some of the things that we did earlier before we had it.
g.
l 1
Q Well, sir, if you could just review your
~
l work paper and perhaps just inform us what version of the
! model was used and what paper it was in so that we perhaps 22 )
23 f can find it.
A We simplysaid that to the extent that people
' - 241
(. ! use betas and capital asset pricing model they may be relying 25,i I
U McHRSACH 6 MAMSH AL. INC. - 27 H. L,4CKWILLev# # VL - >* A RRIS B LIR S. P A. 17112
Brigham-cross 1253 '
I e ggheavilyonthat, and we took betas that were published in a
2 ; Value Line and we took the S&P industrial companies and wa 1
g
,, i;i got the beta coefficient for each of them, and then we broke ,
i g!themdownintofivegroups.
5j We g t the average beta coefficient for each l I f those five groups that had 80 companies in each group, got 6;!
i
.yj the average beta, and then said let's assume that the 6 per-i ggcentriskpremiumappliestotheavercgecompanyandassume 9 ). that the capital asset pricing model is used by investors, 10 j then what risk premium would result for the least risky, f r the 80 companies in the least risky group, the next 11 12 l group, and so on up to the top one.
O
^ 13 g If I recall, we got numbers, if 6 percent y
was the risk premium for the average company, then it might O
15 j have gone down, for the least risky group, to four and a Y
16 ;j half percentage points then up to claybe seven and a hsif percentage points.
I 37 f That was the general procedure.
! 18 l . ti Q From what you said, Dr. Brigham, I have a 19 [ .
1 g ; copy of a book entitled Risk, Capital Costs and Project i d 21 Financing Decisions, edited by a Dutch gentleman who I 22 kl w n' t even attempt to pronounce his name.
1 n 23j A Derkinderen.
1 yg Q Yes, that is the name. It has a 1981 copy-I 25g right. I believe this is the book that you said just came out. h ta A Yes.
' 17182 MCMRB ACH & M AR $N AL. INC. - 27 N. LeCKWNLOVe A VE. - M ARRISetJMG P A.
! l l
l
1254 Bricham-crona
/
,, l f]. As I look at page 100, I believe that is
'4
.e, !!
e the study you just described.
h3
. A That is correct.
o.
I i Q For the record, I believe the group average 4
beta that was used is the unweighted average of Merrill Lynch 5 ;i i
adjusted betas for firms in the group, and I believe you said 6l I I
7g Value Line.
l t A We tually used b th and I guess in the O
0 g published version of it we used the Merrill Lynch betas.
Y "** " *' **
10 Q But this is the --
A That is what I am referring to, yes, 12 b
l 9 13 )
l (Transcript continues on next page.)
g 4
15 i l
16;
}
. 17i '
l b 18' 19 1.I 2o j!
21l n
22l 23i ,
24!
O 25 l i
l M AHRBACH & STARSH AL. INC. - 27 N. LOCKWILLOW AVE.- M ARMISBURG. P A. 37112
Brigham-cross il '
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1 -l Q Just as a matter of preference, l't 2
Dr. Brigham, insofar as betas are concerned, do you hzve a ay Ig 3 P like or dislike of ecmparing Value Lire with Merrill i.ynch?
1
+[ A No. One is based on five years of weekly 3 data and the other is based on monthly data and they are E
6 0 som2what different and there is no uay of telling which, if li !
7 either is any good. !
8i,l Q Now. Dr Brigham, of the three points you
?
9 l mentioned in arriving at your judgment insofar as the various d
10 ) stock risk groups are concerned, ne have discussed the 11 i capital asset pricing model and the Dutch Conference as I i
12 ! shown in the book. I believe you also mentNned some studies
^ 13 j done by Wells Fargo, is that correct, sir?
14 O
A Tes.
15 Q And I believe in response to our i
16 l Interrogatory No. 68 you mentioned that that information was 17 proprietary and you do not have a copy of the data, but you 16 did see computer printouts evidencing apparently the work of 19 Wells Fargo?
I 20 ! A I believe that is correct.
I 21 j Q And do you know who performed that 22 l analysis at Wells Forgo?
4 23 j A Well, there cre several people there. 't he 1
24 one that I recall having talked with most is two of them, 25 ll Mr. Fouse and Mr. Krass, and I have talked with several other O ,
F' 1 MCHRS ACH r t.tARSH AL. INC. - 27 N.1.CC1CVITLLOW AVE. - H ARftlSBURG. PA. 17112 l
l
I Brigham-cros s
____1236 h /
o i .
.n people at Wells Fargo. Those are the two names that I recall.
O zji o And I se11 eve it is the thire acrt used in i a
3 : arriving at your judgmental deci.sion that involved talking 4 with, I assume, pore folio managers and other people involved 5 }l in investments, is that correct? ,
6 I A Yes.
M Y!! THE ADMINISTRATIVE 1AW JUDZ: Let's take 1
8 a 10 minute recess.
9! (A short recess was taken.)
10 ,
TIE ADMINISTRATIV'? IAW JUDGE: Mr. Ryan, t ;
11 do you have a statement to make before we proceed? l 12 MR. RYAN: Yes. Yesterday during the 13 extended day of hearing . , you asked if we would try to indica e 14 when we might be prepare' to put in testimony on the temporary 15 "drate complaint matter acu you suggested that you would like to l 16 do that one of three days next week. We would like'to have 17 ' testimony presented. At this point I can't say that it would 18 be in written form in advance. We would endeavor to do that, 19 but it may well be that the witness would have to appear on 20' the stand and give the testimony. Our consultants are 21 We could produce a witness g Draren and Brubaker Associates.
22 from that firm on either the 18th or the 19th. It would be 23 ; a different consultant either day.
24 I think my preference, if it is agreeable 25 to the other parties, would be the 18th because we would be able MONRSACH C MAR $H AL. INC. - 27 tb LOCKWtLLOW AVC. - HARRfSStJRG. PA. 17312
Brigham-cross 1257 , .
f t I
to have Mark Drazen. Mark Drazen will be our witners ir: our 2h dcaseinthebasereteproceeding,sethereuouldbeacertain' h
- continuity. If it is scheduledfor the 19th, it would be a !
4 different member of that firm that would appear for us. j 5
TIE ADMINISTRATIVE IAN JUDGE: Phat ebout 0f.theotherparties? Do the other parties have any preference? l .
i '
{ MR. BURGRAFF: I only know from discussing!
G fi scheduling matters with Mr. Barasch. .The 18th is Thursdr.y?
11 9l MR. RYAN: That is right.
I i
i 10 MR. BURGRAFF: And do we have Wednesdcy 11 scheduled?
I'" 1 r
MR. RYAN: Yes, Wednesday, Thursday and 13 I[. ; Friday are all scheduled for the hearing in general. " he g 1 4 h question was which of those days would we pick for the 15 i testimony.
16 MR. BURGRAFF: Can your principle be there i
17 l Wednesday?
18 [ MR. RYAN: No, Wednesday is the day we cank i
19 t' not. We can produce a witness Thursday or a different witnes.;
I 20 Friday.
21 h MR BURGRAFF: As I understand it, we still I
22 have a few outstanding interrogatories and I was told we would 23! get them today. If we have the interrogatories and we can 24 proceed on Wednesday, we would have no problem with Thursday.
25 i g
l THE ADMINISTRATIVE IAF JUDGE: Staff wants '
MCHRB Acet & MARSHAL, INC. - 27 R LOCKWILLOW AVE. - HARRISOURG. PA. 17112 l
Brigham-cross- 1253
. I 1
to make a presentation. Will you be ready en Thursday?
O z i, "R. r^NR1W: Tour nonor, t em not su , et !
3 this point whether we will make a presentation and if so, when 4 g we would be ready.
THE ADMINISTRATIVE IAW JUDGE: Do you have 5 k'i 3
6 i any objections to the 18th?
7 MR. rANKIW: I am not prepared to say at 8 ! Your Honor.
lthispoint, 9" THE ADMINISTRATIVE IAW JUDGE: Does the 10 company have any preference?
11 MR. RUSSELL: Not as far as we are aware . ,
i 12 THE ADMINISTRATIVE LAW JUDGE: Well, let's' 13 , fix further hearing on the temporary rate complaint on 14 Thursday, December 18th.
I 15 l MR. RYAN: All right. I will confirm and ll 16 0 have our witnesses in. ,
1 17 MR. RUSSELL: That would'be Draren on the 18 18th?
19 MR. RYAN: It would be Y. ark Dra::en and if 20 it is feasible to put together our rate statement, we will 21 endeavor to do so to deliver it in advance. I don't expect 22 '
extended dir'ect testimony. It is only on that one aspect.
23 l I think our answer we filed today will make it clear what 24 that aspect is.
25 I THE ADMINISTRATIVE LAW JUDGE: If any other MOHRBACH & STAR SHAL. INC. - 27 Nc I;eC3CVALLOW AVE. - HARftiS8t/RG, PA. 10312
"*igham-cross 1259 - -
6 f I
$ l 1 E parties want to file a response and subait testimony in that -
n 2
matter, we would like to have that submitted that dcy. i h
3 MR. RYAN: The same day , j 4 THS ADMINISTRATIVE IM JUDGE: Very well.
5lYoumayproceed. >
q >
0$BYMR.BURGRAFF: !
4 i 7 I believe we left off, Dr. Brigham, with j Q
i 8 ! me looking for an attachment to an interrogatory response. Il; 1
95e found that attachment. It was Attachment A, question 65. and' I
10 0t I believe you have a copy of that. .
y ,
11 0 A Yes, I do. ,
12 ] Q And really, I believe this goes to the
~
II 13 i
general process you describe in Point 3 of page 6 of g 14 f Appendix A of your testimony insofar as portfolio managers 15 are concerned and establish in the required rates of return 4 l 16 $ ' for each stock and the stock risk is listed on that page end 0
17 your discussions with various individuals that have gone into-l 18 h your conclusion regarding risk groups as stated in your u
19 testimony.
20 Now on page 6 of Appendix A you state, 21 R I believe, thereforea second approach to the development of 1
l 22 ,
risk preciums to surveys of portfolio. managers. "To see how I
23 ; this approach is applied, one must understand how the W
24 : portfolio managers of large institutional investors generally
(~)
+
25 operate when they dec!.de to invest or not to invest in a given I
MCHRB ACH Q MARSHAL. IN C. - 27 N. EGCKW1Lt.CW AVE. - HA RRISBURG. PA. 178t2 l
Brigham-crocs 1260
- i f
'Ilstoch",andyousetforthbasicallyafourstepprocedureon i O zige8ee6eoa7.iethatcorrect !
G A Yes, it is.
3l l 4 , Q Now in Interrogatory No. 67 I believe we f
!i 5 l asked you the institutions utilizin;; such an investment n
6II lh I decision process and you mentioned two names in your interrogatory response. Do you have that response? l 7[d l 6 A Yes. j i !
9 1 f
Q And those two were the First National i
~
f 10 i Lank of Boston and 3quitable Life, is that correct?
l !
11 ' A That is correct. i i
12 li Q Appendix A on page 6, I believe, you state 13 a DCF rate of return and this is the first sentence under l 14lI .l. "(Dividend yield plus capital gains yield) is estimated 1
is for each stock under cc s :ideration."
Il Do you see that, sir?
16 h 17 A Yes.
18 ' Q Are you able to specifically state..that, 19 for instance, Equitable Life estimates a DCF rate of return 20 for each stock under consideration?
21 i A My recollection is that their security' l
22 l analysts project the sales and revenues and costs, number of l l l 23 3 shares of stock outstanding, and si forth, for companies out for some period of time and I don' t recall in that case l 24 fll 25 exactly how far out they projected, but. they project l
MOHRBACH & M ARSH AL.1HC. - 27 P4/ tOCMWILLOW AVE.
- HARRISBtMtG. PA. 17112
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1 1
!! / !
- i 3
I 1j essentially the earnings of the company.
Then they projact l 29: the dividend pcyour cad from that they derive the projec:ed E
3g divident per share over some forecast , and then they would ,
4 have a horizon beyond which they don't nake specific year-a k i
- 5) by-year projections, and then they would find the present i h
6 [ value, discounted value of that expectet are stream of n
7j dividends and they could find the rate of return that brings!
2 8f that projected stream of dividends back to equal the currem !
i
?[ price of the stock, and that would be the DCF rate of return i, :
C .
10 d and that is the procedure that organizations tend to use. I
?
11 h Q But your statesent that Squitable doea do b i I
12 that, you are specifically aware of that? l
\ l 13 L A That is tha impression that I have. Yca
{}' : til 14 L know, tha situation the* I find myself in is that I have been talking with these people for 20 years and then your data 15 )l i
r !
16l request says give me the name, dates, notes and conversations
(
, 17 h with everybody you have talked to and I' tried to be as l l 18
- responsive as I could by giving you some indication of the 19 s types of organizations and people that I had talked to, and d with 20 I did spend a day / Equitable Life, spent time with other 21ii institutional investors.
i 22 i I have talked to a lot of them on the 23 i telephone and at meetings, this Ednd of thing, and I have a E .
,r . 24 general impression in the case of Equitable. I believe that li 25 1 is what they do. I know that is what Wells Fargo does. I !
l .vous Acu a no s>ua me. .U k LGCNLOW AVE. - HMm8 B UR G. P A. mM
. Brightm-cross 1262 j
1 know that is what First National Bank of Boston does and I r~ ,
C 2 lbelievethe*iswhattheEquitableLifedoes.
3 It is what all the textbooks teach that l 4&ought to be done and the NBA's that are coming out are 1
5 hired by these people. The impression that I have is it is l r t 0ldone. !
l 7 Now Dr. Brigham, if we drop down on page Q l 8 6 of Appendix A to the actual five risk groups,' preceding l 9 I that listing you state: "For the S & P 400 stocks, these 10 '
premiums appear typically to be established at rates close tof 11 l the following:" Do you see that, sir?
12 f A Yes.
O o verheve 1 coerd 3eet h9 reee it tht we7 14 i Perhaps you could just tell me what is -intended by the use I
15 i of the word close and also perhaps you could tell me which of 16 the groups we are discussing, i. e., Equitable,First 17 National Bank of' Boston, WellsFargo, and .any other group 18 you would care to name actually said or' actually said we have i
19 '
done this and our risk groups break down as foilows, for l
20 the five groups and for the numbers.
21 22 23 241 qL 25 MCMftDACH & ?A AR SHAL. INC. - 17 N. LGCXW.LLOW A VE. = 14ARRL5 BURG, PA. IFt12
Brigham-cross 1263 -
I
, f 1H A As I indicated on Page 6, the information li l-given on Page 6 would represent a composite in my judgmental g 3 'I recollection of what the average company does.
I l 4 ll Now possibly no specific company does exactly-lI 5lwhatIhaveshownonPage6. Different companies will do 0hdifferentthings.
l I ', The analogy that I like to think about is 8 that if you ask what the average size of s family in the 9 -
l U. S. is, it might be 3.2 family members. There is not any l
10 jfamilythathas3.2familymembers.
11 My impression is that it is conceivable 12 that no organization does exactly what is shown on Page 6, 13
({' and I did not represent it to be that way.
g 14 But what is shown on Page 6 is my impression 15l from talking with a number of organizations and representa-h 16! tives of organizations, chct that is the general ballpark 17 set of' numbers that is used.
18 Then I go on in the following 30 pages or so 19 f to get a better refinement of it.
20 This is an illustrative situation. It-is
)
21i not what I rely primarily on in the testimony. This is what 22 it is.
23 Yes, I understand, sir, but to the extent Q
- n. 24 that you rely on your discussions.with various people and to 25 s O l the extent that this at least seems to track what range you MOHRB ACH & MARSHAL. INC. - 2* N. LeCKWILLOW AVE. - M AR RISBUMS. PA. 17112
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1 ;; are using, I am just wondering, in your conversation, say,
- i Q 3 j.! with the First National Bank of Boston, did they say our s
3 i stock risk group, our analysis, shows five classifications 4 and those five classifications fall somewhere within the renge' 5, of. numbers that you show for illustrative purposes on Page 67 0
0lImean, is that where it came from?
? j' A That is my impression of what they do. I can l ;
8 l remember computer printouts where they had classes of stocks, 9 j and I believe 'they used five groups, and in cach group ther 10 had the name of the company and the expected rate of return, 11 the DCF rate of return, and the companies that were in the 13 I lowest risk group had the lowest expected rates of return, 13 ] generally, and the highest risk groups had higher rates of 14 return.
15 That information was developed essentially 16 k by analysts, different analysts dealing with different groups 17 of stocks, and then they were putting them"all together in 18 the main computer and then that information was made 19 available to the portfolio managers handling different 20 accounts.
21 Different portfolio managers,would. manage.
22 different portfolios within the bank. The portfolio 23 I managers would then apply their own judgment to the expected
{
24 rates of return that the analysts were coming up with and 25 ; comparing them with purchase of low risk fixed income MOHRBACH & ttARSHAt INC. - 27 N. i.eCKWNLCW AVE.- M AR RIS SLfTtG. PA. 17112
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1 ;I securities.
1 2 In mf -iiscussion: with the portfolio g
managers and essentiallJ the supervisors of the portfolic 3l 4 managers we talked about the precision.
In an earlier version of the paper, actus.lly 5l i
6 i, the version that you have in that book that was presente6 in
? the Netherlands, when I finished the paper I sent the paper 8ltotheFirstNationalBankofBostonandaskedthemfor 9 com:nents . I don' t think I got any written coments frcm 10 , them. I think I called them up and talked to them and they h
11 ll said generally, as I recall, that they were in agreement with' 12 it.
'l 13 But I sent copies of that paper to a number 14 '
1
. of people and got responses from a number of them, and bcsed e
l 15 on that, that is what we have got here on Page 6.
! 16hi Q I understand your response, Dr. Brigham, l 1 17 but I would like an answer to one part of my question I 18 J am not sure you answered, and that is, particularly the use a
19 of the five risk classifications and the actual numbers you i
20 f show here.
I 21' Is it your testimony that the institutions, 22 l at least the ones we are talking about -- Equitable, First h
23 il National, Wells Fargo -- in your conversations they 1
24 h expressly said yes, we have five ranges and, yes, our 25 i g lnumbersarethesenumbersornumberssimilartheretoorour 17112 MOHRBACH & M ARSHAL. INC. - 27 N. LOCKWILLOW AVE. - H A,'t f* t S S UH G. P A.
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/
1 risk premium analysis shows close to what you are saying?
3 Q A I am absolutely positive that Wells Fargo 3 uses five risk classes. I believe the others did but they 4 could use more or less. They had different groups.
5 The First National Bank of Boston definitely 6 had five groups. It may not have been fire, it may have been 7 four, five or six.
8 The risk premiums are not something that 9 would normally be set by an organization but it is normally 10 something that a portfolio manager ~-- portfolio managers use 11 their own judgment -- and an orgar.ization like. the First 12 National Bank of Boston would have several billions of dollarb 13 broken down into a number of different portfolios.
14 They would have a portfolio for, say, 15 General Motors, if .they were managing part of General Motors' 16 pension plan, IBM, the various companies whose pension plans i
17 they are managing.
18 Then the individual portfolio managers would 19 have the information available on corporate bonds, Treasury 20 9 Bonds. They would have the analyst's forecasts as to what l
21 the expected rates return are on different individual stocks i
22 and averages for different groups.
, 23l Then the portfolio managers would apply
, 't q 24 their own judgment which could differ from portfolio manager J
25 to portfolio manager.
k MOMRBAC11 ts MARSHAL, INC. - 27 84. ESCICWILLOW AVE. - HAftRISBUitG. PA. 17182
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If One that happened to be more conservative g would use a larger risk premium. One that was less g 3Iconservativewoulduseasmallerriskpremium. It would be a i
- 4. { judgmental matter.
I!
54 I don't think anybody would say that we have 6 y hard and fast rules as to what exactly should be used. ,
l l
? jl Even an organization like Wells Faro th t i n
8 would be relatively rigid in the way they operate -- rigid 9linthesensethattheyapplywhattheycallthesecurity .
N l 10 l market plane concept, which is similar to the capital asset :
r 11h pricing model -- they would get expected returns on stocks 0
12 - and they would know what the long-tem bond rate was, and
- then individual stocks would be either on or off, higher or 13 14 i lower than the security market plane expected return would i
15.! be or required return would have been and the portfolio N.
16 ; managers would make decisions.
i 17 The investment process is one that does have 18 l a degree of judgment and I don't think anybody would say
'19 lweadhererigidlytothesenumbersthatyouhaveonPage6..
l 20 !! What they did say was the numbers you have
!i 21 got on Page 6 seem to be not unreasonable numbers and not 22 3 out of the ballpark for the way our people would operate.
l 23 ii Q offhand, Dr. Brigham, how many investors 24 i besides Wells Fargo employ a stock risk group of five O
25 g classifications?
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1 A I have never made an effort to try to lC 2! quantify that. There are some 14,000 organizations defited 3 , as either institutional investors or advisors, security 4 advisors, some 14,000 of them, and I have not made an effort 5 to determine how they operate and what sort of breakdown 6 they use, primarily because I think it is not really a 7 relevant question.
8 We want to know generally how they operate.
9 I do know that the ones that publish information, that I 10 have seen published information, such as the ones I have 11 roentioned, such as value Line, the published information 12 tends generally to'use five groups.
pg 13 Value Line classifies companies into five
! V 14 different risk classes. That seems to be the number. But 15 as I have indicated some organizations tend to use more, 16i some tend to use less.
17 At the extreme each company could be treated 18 as an individual risk class. That tends not to be done 19 because people don't tend to have that much faith in any 20 risk measured for an individual company.
21ll Q I believe in your prior answer you mentioned 5
22 security market plane of Wells Fargo. Is that essentially 23 a capital asset pricing model?
24 A The capital asset pricing model approach in 25 its pure and simple form says that the expected and required MCHRB ACH a M ARSHAL. INC. - 27 N. LeCKWILLOW AVE. - HARRISSuttG. PA. 17112
1269
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t 5
i i l return on a security is equal to some intercept term, the ,
g ;: intercept term being close to a risk free rate, plus a risk l 3lpremiumthat is determined only by the beta coefficient, t
!h f,,jsystematicriskcoefficient.
5 The security market plane as I understand it I 6 j has two variables, one that has a beta coefficient, a i 6 '
7 E systematic risk component, and secondly it has a dividend 0
a l yield cocaponent.
gi So it is essentially a two variable model ,
i i4 l 10 l whereas the capital asset pricing model is essentially a N
11 one variable model. !
12 g Q I am not sure you answered my question.
9 0
^U 13 l What Wells Fargo employs in the analysis you were discussing 14 i was essentially a capital asset pricing model to the best g
U 15IOf 7'ur knowledge?
i 16 l A It employs an element of the capital asset l 17 f p ricing model, the beta coefficient but then it extends it t
IS and they think -- and I have not investigated it' myself --
n 19 l they think that extending the capital asset pricing model to 20 include a dividend yield variable provides more accurate i 31lresults.
A 1
I 22 Q Now, as I understand what you are testifying h
23 s to, Dr. Brigham, insofar as discussions are concerned with 1
,m 24) portfolio managers -- first of all, before I get into that, i
25 a
if you have OCA Question No. 65, Attach:nent A --
g i
k k
j M cHRB ACH & M AR SH AL. INC. - 27 N. LOCKW ALCW AVE.- h A R RIS B UStG. PA. 17312 1
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11 A 1 do.
h O g ij Q 1 believe thic is a list you provided of 3 individuals you have discussed some of these ideas with, is a
I j, that correct?
57 A Well, you asked me who have you talked to, i
6 ( names and addresses, and all that kind of thing, and I sat 1
l 7 down and thought about the nanes of people that I could think 8lofthatImighthavetalkedtooverthelast15or20 years i
gl and this is the list.
I, 10 ll I am sure had I ti ought lenger I probably it could have come up with some other names.
12 Q How many of these people would you ce.tegorize 3 13I i as portfolio managers, Dr. Brigham? And in making that (V j 14 i categorization perhaps you can state for the record how you 15 h are defining portfolio manager.
I!
16l A Strictly speaking a portfolio manager would I.
17 p be defined in a number of different ways. At one extreme a I
18 ' Portfolio manager could be someone who was given a sum of i
l 19 {l money and then told to invest it, told what the objectives l
l 20- of the beneficiary were, and given discretionary power to l
21 invest that money for the beneficiary. That would be the i
22 fmostextremetypeversionofaportfoliomanager.
3 Then it starte moving down to where the 23]!!
y person would become more of an advisor and not have 25 discretionary power to invest the funds.
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1 ! In my perception of it thera is soma degree
^ !
g I! of overlap between the person functioning as a security O
3 f analyst and someone functioning as a portfolio manager with-4 'out discretion, someone functioning as a portfolio manager 5 with this discretion over the funds, then there would be 61 another level and that would be essentially a supervisor of I
i 7jportfoliocanagers.
8 If you look at, as an example, the First l
!! I' gfNationalBankofBoston,EdRileyistheVicePresident in 10 t ichargeofequityinvestmentsfortheFirstNationalBankof I
11 l Bocton's Trust Department and I cannot remember at this 12 ! point whether Alridge, McCollough and Bourcue -- they had i I I
13 all managed portfolios -- they may and may not -- I believe 14 one of those three actually managed at that particular point O
E 15 g in time specific portfolios.
3..
?,j Riley certainly had but he did not actively il 17 l manage portfolios at that point in time. He was supervisor 18 of maybe 15 portfolio managers.
19 l Q Perhaps just to shorten it, Dr. Brigham, we 1
20 could leave a definition as I believe you stated, someone 21 who had management responsibilities over a portfolio with 22 i discretion, which I assume would be one of your stricter l
231 definition,, and perhaps you can just provide to us who en N
- 24 j Attachment A would fit that category. I mean not orally, G7 !
25 ' you r.an just do it in writing. $
Ih
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t < .
1 l: MR. RUSSELL: Do it in writing?
Q 3l MR. BURGRAFF: Well, if he can do it now 3fthatisfine. I was just trying to shorten the process.
4 THE WITNESS: I am not sure that I would 5 l ever be able to do it. I can tell you that John Bogle ic 6 Chairman and President of an organication called Gemini Fund.
7 He is also President of a number of other funds that are 8 part of, I believe, the Wellington Management Group.
9 If you talk to him, then he would, on the 10 one hand, say that there are portfolio managers that work 11 for him, and on the other hand be is going to sey that he 12 talks to those portfolio managers and as their b:ss and r
ps 13 q supervisor he is going to give them a lot of inputs.
k) [
.14 ! Earl Foster at the Southeast Bankcorp is
- I l 15j in charie of equity investments for that group. He may or 16! may not say he is a portfolio manager.
17 a For the purposes of my testimony I think all il 18 of these people have given me information and have in one 19 form or another contributed to my judgment.
20 I guess it would be difficult to write to 21 ,
every organization that I have had anything to do with and 22 try to find out who currently is managing portfolios and 23 give you a list of people, but I don't believe that would be
- g. 24 productive, and it is not the way I operate.
L 25 I t.alked to these people generally as high j t m oana,cw . unsm. me. - a n. i..smu. w evt. - wanar. u,io na. i7 ia I
1
s '
Brinham-cross 1273 8 , ;
, e .
1 l up in the company as I could and got information as to how 1,
2.jtheorganizationmadeinvestmentdecisions. g i
3 t1 Q Returning to Page 6 once again in
[jAppendixA,asIunderstandwhatyouaretestifyingto, f
5 Dr. Brigham, it is that these groups don't necessarily give a
6 you any particular information vis-a-vis numbers, say, or, l
?tj say, risk premiums over double-A corporate bonds, but they G respond to apparently what your judgment reveals.
9 Ji So perhaps the question should be, in regard 10 l, to what is shown on Page 6 of Appendix A, for your risk N
11 j Premiums for stocks over double-A corporate bonds, I take it 12 .
these are your estimates, and what period of time did you 13 form these estimates?
g 141, f 15 l
,i 16; l
17lp (Transcript continued on next page.)
i is }
19 l
20 21[
22 l h
23 4 24
.) O 25 ;
- MOMM8ACH e. M ARSHAL. INC. - 27 Ni LCCKWILLOW A */E. - M AR Rl5 BURG, PA. 17112
- . Brigh m-cross 1274 i /
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l 1 l A various periods of time from the 1960's toj i 1 2 f the current time, but primsrily they reflect my perceptionc l t
3 ! of risk premiums that existed in say the period 1978, 1979 ,
l 4 { and 1980. I believe the average would probably have been I i Sj lower had I specifically been constructing that page in the ,
)
p 6lmid1960's. I believe it would have been icwer.
sl 7k Q Dr. Brigham, I have a copy of testimony I l
8 l believe you presented for the Georgia Public Service P
9 Com:nission in a Georgia Power Company Case docketed at i
10 ! 3129-U. Do you recall thet? l 11 ) A What date was that?
I 12 Q I have a received date of November 1978 13 '
and I believe your cross-examination was on March 2, 1979.
14 A I don' t recall the docket number.
15 : Q Well, I have the testimony. I will show 16 j it to you-17 l Do you recall the date of cross-examination 18 4 as March 2, 1979? Does that sound familiar?
19 A I believe I have the transcript. Well, l
20 in that particular case' there were hearings, there were -
21 ,
cross-examinations i~n March and then the Commission rejected 22 the company's application and the company took it to court
. .I l ,
23 fandtheorderorderedthecommissiontoreconvene. There l
24 was subsecuent cross examination and I believe in July so 25 ,
that proceeding went on for a period o' f time. There were
! MOMRDACH e ht ARSHAL. 8HC. - 27 Nc LeCKWELLOW AVE. - H ARRl59tfftG. PA. 17112
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1ltwocross-examinationsonthesametestimony.
~ fj 2k Q But insofar as your direct testimony he-s j$
h n
3j is concerned, Dr. Brigham, I believe this is under Point 3 1
4 j on page 12 which once again discusses portfolio managers.
i 5 il and I believe there is four steps used here as well and you l 4
6 ji Are comparing the risk premium over Double A corjiorate bonds ':l n i 7 0 and would you agree with me, sir, that a stock risk group 8
j of five similar to what is in the present testimony and your i
9 risk premium over Double A corporate bonds for those five l I
10 l classifications ranges from 4 percent to 6 percent? l 9
l 11 l A Yes. I will also note that that is very i 12 I close to what is on page 6 of Appendix A. 1
{ 13 Q Page 6 of what?
g 14 A Page 6 of Appendix A to this testimony.
15I l Page 6, I think, has been defined a bit and shows range where 16 it only shows one number.
i 17 ;
Q Yes, that is correct. For the record. I e
18 might add that the lowest risk Sroup is 4.0, the second i
19 lowest is 4.5, average 5.0, second highest risk, 5.5, highest ,
20 i 6.0.
21 ( A It is important to note those are based 1
l 22 } on Double A's and in this testimony I am basing it on i
23 treasury securities for the risk. The premiums that you just 24 read out are not directly comparable to what I used in the g
25 ltestimonypartofthisproceeding.
I 17152 MONMBACH & f.t AR SHAL. INC. = 27 N 1.OGJCWK LOW AVE " HARRISBUR G. PA.
. Brightm-crcss 1276 s e e ,
1;g r. I don' t have the testimony part . I cn !
g .
O 2i makias a comeartson to rese e or ^Peendtx ^. .
C 3g A Double A corporate bend is shown on there.,
i 4g Q Now as I read what we just discussed as 4
5 l your Georgia testimony in docket 3129-U, your range of risk E
6 g premiums over Double A corporate bonds is 2 percent, is that !
n 7 f correct, as shewn c: the testicony at page 4? ;
5 1 8U A At midpoint, yes. !
k 9 Q Would it be correct, sir, that in the it i
10 l Georgia Power Proceeding, which we sre discussing, whert- you '
11- sponsored the document we are looking at, that you were n i 12 l cross-examined on a document at some point in 1979? l 13 gl \
qb p A Yes. -
j 14 Q And I believe at that time you defended l r l
15 { your testimony obviously, is that correct? You made no p I 16 j changes in this particular page we are looking at?
l 17 A I don' t recall having made any.
I 18 Q I guess my question, Dr. Brigham, is l
)
19 d since your cross-examination in the Georgia proceeding with and 20 regard to your dealings with portfolio managers /in your l
l 21 j general knowledge in discussions with other individuals in l 22 j the interim timeframe, what contributes to the difference in l 'i l
1 23 ! ranges as shown in your Georgia testimony and what you have 1 .
?\ 24 l presented in Appendix A on page 6 vis-avis Double A 1 LJ !
25 corporate bonds?
Brighau-srous 1277 *
/ I I
1 Well, the Georgia testimony, that was s i
I have 2 relatively early in my career piece of testimony and g
2 subsequently talked to more people and I think gotten additicaal 4 f information and in this testimony, as represented'in Appendix 5 : A, I have I think derived somewhat mere in a sense' precise t
6 l estimates end in another sence in this testimony I indicate i
7 g a rcnge for each group becaure to reflect the fact that therej l: s 8l 1s some uncertainty because es we hava indicated, people cadt!
9 f and won' t tell you exactly what they think because probably l 1 i 10 { because they don't really know because they change somewhat l
- ! i 11 over time, so here I have tended to use rather than 4 percent.'
t' i 12 ( in the low risk group, I have tended to use 3 to 4 to l
^ k I
/
13 '1 indicate there is some fuzziness in it. Wherean, in that g
14 d one I used 4 exactly or I only gave 4, but I think this data n
15 l simply reflects the fact that since that testimony was filed, 16 it is approximately one year and a half to two years, and I i i 17 i think I knew more now than 1 knew then.
18 Q I guess what I am asking, Dr. Brigham, I 19 am not questioning as opposed to giving one number you give 20 a range, but at least then--I assume the testimony was 21 !j Prepared in 1978 if you can recall?
i 22 l A Probably in mid 1998.
l 23 Q nut you show a lowest risk of 4.0 and that:
6
- i. 24 lowest risk basically is within the same range you show in v
k 25 h Appendix A of 3.54?
), i e
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Brighan-cross 1278 1278 r
l .
1 A Yes.
l O 2 i a nouever your increments working through 3 (yourhighrange go from 6.0 to 5.5 to 8.0. I guess what I i
4 l am asking you is what is happening within the interim? Wha t 5; specifically have you relied on that allows you to be more i .
6 specific or has led you to change the range? I 7 i A Well, in the high risk group, my considerep 8 opinion at this point in time is that there have been some 9 l events that have taken place that make me think that the most.
I 10 risky 80 companies within the S & P industrial group, peoples l,'
11 perception of the riskiness of the lowest risk of that 80 12 companies and the highest risk of that 80 companies is wider 13 than it was at an earlier point. We have had some large 34 bankruptcies. W2 have had some companies like Chrysler 15 that hr.ve not gone bankrupt, but have gotten obviously into 16 '
difficulty. I think now there is more heterogeneity as l 17 opposed to homogeneity of expectations in that risky group.
I 18 If we were talking about the utilities 19 per se, I think the existence of the TMI accident would tend 20 to spread the electric utilities out, spread their perceived 11 '
risk out. The same kind of thing is. happening in the 22 '
industrial sector, I think, and the perception I get from 23? talking with people is that the range of required returns
- 24 in the risky group is wider today than it was a'. couple of 25 years ago and I have reflected that on Appendix A.
McHABACH Ks N AMSHAL. INC. - 27 N. LOCKWILLOW AVE. " HARRISBURG. PA. 17182
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n Ik Q Now is it your testimony: Dr. 3righam, .
.d i
that this change which you have reflected in Appendix A, '$
3 page 6, is based on discussions with portfolio managers ?
4 Well, based on discussions with whom? Let's put it that way.
1 5j A Purely the ones that we were talking l 6
about before. In the Georgie testimony, as I indicated it i 7 earlier, that was one of the fire tin.es that I had used 8 that approach in a regulatory proceeding and then as I filad o
! additional testimony and not actually when I was filing 10 N l testimony, but when I aould go to academic meetings , having 11 1 been cross-examined in Georgia and other jurisdictions , I N
12 think I naturally wanted to refine my thinking on it, try to Q 13 get better estimates, so I probably paid more attention or g 14 9 thought more about it when I talked to people like well, let' a 15 see. 1979, at the Financial Management meetings in 16 f Minneapolis, I made a specific point to have dinner with a l 17 man by the name of Scott Bowman, who was the Director of the
~
18 1 Institute of Chartered Financial Analysts group, specifically 19 to talk about these things and in discussing the kinds of i
20 l things that we are discussing now and the process of that 21 decision and othern that were similar.
I 22 ! I simply broadened the band and changed 23 .
somewhat the means of numbers that are shown on page 6.
24 O l xx. gy,cgt,y, 1 tsi,x est, ,,,1,s , ,
25 l' good McHRB pointACHto&break.
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l # .
7 THE ADMINISTRATIVE LAW JUDGE: : Let's 2- recess until 2:00 o' clock.
O (A recess was taken from 12:55 o' clock p.m.
4 , to 2:00 o' clock p.m.)
5 (Testimony continued on next page )
6 7 ,
8 1
9 10 11 ,
12 13 -
@o
.14 15 16 17 1 l
16 4
19 20 21 1
21 I .
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1; AFTERNOON SESSION j 1
. t 7, --o0o--
g 3l (The hearing resumed at 2:14. o' clock p.m.)
t
- 4. j --o0o--
I 5h 9
6i EUGENE F. BRIGHAM, resumed.
7 BY MR. BURGRAFF:
8l Q I would just like to move off Page 6, if I 9 could, Dr. Brigham. However, I would like to summarize one 10 ! or two things if I could.
i On this. list of individuals you provided us, 11 ll 12 ' Attachment A to Interrogatory 65, do you have specific 13 r ecollection as to exactly which people on that list
{ i s 9 14 f specifically noted the changes in the risk premiums for the i
t 15 [ five groups we have been talking about over double-A 16 '. corporate bonds?
I 17 ; A No, I don't.
i 18 f Q By any chance, sir, did you take any notes i
of your conversations with these individuals?
19{
20[: A No.
i 21i Q I believe you stated -- at least insofar as l 22 f Wells Fargo was concerned -- they derive their risk rankings 23 by the use of betas. Is that correct, to the best of your 24 knowledge?
ld A They are betas but they are not historie g
l 25 ;
MOHRBACH & MARSHAL. INC. - 27 N. LOCKWILLOW AVE. - M A R R 168 U19 G. P A. 17112 l
l I
l
Brigham-cross 1281 3 f betas, they are what are called fundamental betas. They
,Q g obtain those betas from an organization called Barr 3 l Rosenberg Associates.
l 4 It is a CAPM approach but it is not the CAFM 5 h approach using strictly historic data.
1 6l I might also add with regard to Wells Fargo
- i .
7 they do not use historic returns to derive the market risk 8, premium, either. They use analysts' forecasted expected 9l return average for the companies in their sample, very 10 $ similar to the procedure that I describe in Appendix A.
T 11 h Q I believe earlier, sir, you stated that your 12 Appendix A that you presented in this case is the sequel 13 so to speak, to the article in the book entitled Risks, 14 Capital Costs and Project Financing Decisions which you 15 : looked at this morning, is that correct?
'J 16 ! A Yes.
17 Q I would like to show you Pages 96 and 97 of l '
i 18 that book if I could.
I 19 A All right.
l 20 Q Now those two pages show two tableo l
21 evidencing valuated risk premiums using aggregate market 22 ,
data for the years 1963 through 1978, is that correct?
h 23 A Yes.
24 Q And you valuated risk premiums using both a l 25 four year weighted average, based upon four year weighted it MOH 48 ACH & M ARSHAL. INC. - 2T Mc ESCJCWiLLOW AVL - H AR R IS S U9*G. P A, t7112
Bricham-cenan 1282 1 average data, and that is the top table, and a five year 3 simple average data which is the second ttble, is that g 3 Corr 2C t?
4p A Yes.
5 Q As I recall, this is the S&P 400, is that 6 l{' right?
l !
l 7' A I believe it is S&P 399 which is the 400 l
8 minus AT&T on the grounds that AT&T is not an industrial 9 g company.
10 ,
Q Now if one looked at the year 1978 under 1
it both Table 4 and Table 5 in the book -- and whenever I use 12 the book that refers to Risk, Capital Costs and Project i
13 ! Financin8 eCiSi n8 -- depending upon whether you use the O
.14 fcur year average weighted data or the five year simple 15 / average data, the risk premium for 1978 changes by 79 basis 16 Points is tha t correct, sir?
17 A one is 7.9 percent, the other is 8.69 18 Percent, so they are both extremely high. There is a 19 difference, as you indicated, of 90 basis points, yes.
4 ~
20 Q I'm sorry, 797 21 A That is about right.
22 i Q If I ask you the same question as the last J
23 l' question, the differences for 1976 would be 100 basis points
.- 24 and 1977 would be 89 basis points, is that correct?
23 A Yes, but again note that everyone of those
'I woan=4cw a ux= swan. inc. - me n. toexwiuow Ave. - waariisstrao. r^- i7 iz
i i
Brigham-cross 1283 j;
p f 1 (l numbers, five out of six of them, are higher than the rith O :- e=~':um tuet 1 ueee ta the teeti=oa> ro= the ave =ase !
l '
1.; company. g 5
l 4j ; Yes, I understand, i. am just comparing the f 1 I 5 risk premiums that are the results for the same yecrs but 6 ! using different weighted averages. In fac c, Dr. Brighum, j
? l if we use the .79 differential in risk premium, 79 basis W
8 l points, between the two methodologies, for the year 1978 and l 9t ecmpared it to the Table 4 value for 1978 cf 7.90, that is i i 10 appronimately one percentage point differential, is that 11 right?
12 : A The numbers are as you scate. The numbers i'
, 13 that you state have a certain lack of relevance and I think l 14 that is indicated by the fact '; hat what you really ought to 15 be looking at are the averages or the moving averages and we recognized when we wrote the article that, depending on 16.)i 17 what you use in a specific year you do get a certain amount u
18 fofnoiseorrandomnessinthesystemandwehaveneverused 19 specific numbers for a particular year.
I l 20' If you look at it over time and look at the 21' averages, the two tables are much more similar.
f 22 0 The relevant thing to look at is what we call 23 the smooth data using moving averages that average over the l
24 whole period.
25 But it is certainly true that if you look at l
IJOHRS ACH A MARSHAL. INC. - 2.7 N. t.CCKWILLOW AVE." H AArtlS SU7tG. PA. 17112 k
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l! ' l I N individual years you do get differences between the two i c il
! 7, tables.
i g
5 ! Q And you employed a five yecr moving average !
l 4 ' in the article in the book?
56 A Yes, we did. We used various types of Il 6 moving averages. In this particular case we did report a 7l five year moving average.
Si Q You would agree, sir, depending on which of P the methods that is used there will be.a change in the rist 10 g' premium for any particular year?
I 11 h A That is correct. One has to use j udgment in 12 ) applying the method. There is a range and the range is
~'
13 quite consistent with the numbers used in the testimony.
You notice the lowest numbers that you are O
14 l 15 ever going to find there would be 3.88 percent of the risk 16" premium, the highest numbers would be the ones most recently, 17 g up to 8.69 percent.
18 As I indicated earlier, I think the true
,i 19' lriskpremiumismovingwithinarange.
I 1 20 The two tables give two alternative methods 1
21 of estimating that range.
22 h Q Perhaps just illustrative of the different N
23 answers depending on the methodology, if one looked at 24l Table 4, the difference between the risk premium for --
25 i MR. BURGRAFF: Scratch that question.
9 MOMRSACH & '4ARSHA1 INC. - 2c Ne LOCKWILLOW AVE. - M A R eiss uR G. PA. 17112
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Ic THE WITNESS: If you use che most recent risk l h 2 pre:riums applied to today's rate of return you would get a 3 l cost of capital --
4 4 : BY MR. BURGRAFF:
5 g Q There is no outstanding question, Doctor.
6 I Indeed, Dr. Brigham, if we looked at Table 4 and Table I and t
y 7 e also looked at Table 2 on Page 17 of Appendix A, which is
! I 8 i your estimated risk premium constant growth from 1964 through I
9 1 1979 for the S&P 399, one would also find variations in h
10 l covements in risk premiums from year to year, is that U
11 }i correct?
12 A Yes, relativeIy small movements from year to 13 year.
14 Q Perhaps we can look at the years 1977 and 15f1978. Table 4, the risk premium would have advanced 0
16 [ approximately 39 basis points. Table 5 advanced over 200 17 basis points. On Table 2 in your Appendix A, advanced i
13 ,
approximately 53 basis points, is that correct?
19!. MR. RUdSELL: If Yor - Honor please, I must 20 f interpose an objection to this crost,-examination with t
21 respect to minutia. It is getting us absolutely nowhere and 22 it has reached the point not only of immateriality, I think l
23 s of becoming irrelevant.
I i 6 24 i MR. EURGRAFF: Well, Your Honor, it
!U 25
} certainly is not irrelevant. What we are trying to 1
E- MOHRBACM & M ARSHAI INC. - 27 N. Et; 4 WILLOW /NE. - H AR m;S e t/MG P A.
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e .
1 establish for the record is depending upon the methodology
^
g used one cari indeed come up uith different risk premium (gg 3 h numbers for the same year and that is all w2 are doing.
W MR. RUSSELL: Are you cros s-examining hia
,;, i 3 with respect to his testimony or somebody else's theories?
6 I think it is somebody else's theories.
ll 7i MR. BURGRAFF: No, I cm sorry. The artic7.e B that we are referring to, the tuo tables, was performed by Dr. Erigham and Mr. $home, and of course, Dr. Brigham's
?{
}
- oj testimony was performed by him as well.
lii We are not talking about someone else's
~
11 12 theories.
(-
s 13 '!
i THE ADMn?ISTRATIVE LAW JUDGE: We will 1
J4 overrule the objection. I think we are spending an 15 f inordinate time on the risk premium aspect but go ahead.
16 } MR. BURGRAFF: I will attempt to shorten it, i
17 Your Honor. Could I have the last question repeated?
I 18 !
l
}
l 19 q (The following was read by the reporter:
i 20 ; Question: Perhaps we can look at the i
21 years 1977 and 1978. Table 4, the risk 22 ! premium would have advanced approximately 39 i
23 .! basis noints. Table 5 edvanced over 200 V
I
,- 24. q basis points. On Table 2 in your Appendin A,
.' , llh 25 advanced approximately 53 basis points, is
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1 .
- g that correct?
O 2.
l 3g THE WITNESS: Well, the answer has severcl l
4 parts. One, if you look at the moving averages -- which I 5:i indicated in the book are probably more relevant than the
' 1 6I individual year to year data because of the randomness tha:
l t 7 you get -- then the numbers that you quoted would be correct.
L i If you looked at the moving averages then 8[
9 the moving averages would be significantly lower, the 10 l differences would be much lower.
11 l In any event, there is a difference between i
12 the table on Page 17 of Appendix A of the testimony and 13 Tables 4 and 5 in the book.
i 14 One difference is that the testimony reflects 15 an additional year and a half of research that we have done l 16 ! and better methodologies and there is a difference between 17 what we would have gotten using the methodology that we used 18 a couple years ago and what we get using today's 19 methodology. That is certainly correct.
20 But when you look at the year to year 21 fluctuations you are doing something that we did not do, 22 because we thought that the year to year fluctuations were 23 not reflective.
p -I have never used those year to year O U i
numbers in either testimony or other types of work.
25 I a wonnsacs a urnsuAL. INC. - 27 H. LeCXWLLLOW AVL - N Ameiseuves PA. 17412
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1288 1, e p i 1l I think you always have to smooth it by using i
2 some form of moving average to get rid of the randomness in g 3 ' the data from year to year.
l 4 BY MR. BURGRAFF:
5 I Q Is there any pcrticular reason, Dr. Brighani, i
6 that you employed a three year centered moving average in 7 i Appendix A as opposed to a five year avercge?
I 8 A Not really. We could have used a three year l'
9 l moving average in the book, three years or five years. What i
10 lwearesimplytryingtodoisreflectthefactthatthereis i
11 randomness in the data on an annual basis. It is better to 12 smooth out the data to remove some of that randomness.
{; 13 There is no theoretical reason for using the g
14 three year, four year, five year. All we ar; trying to do l
l 15 lisremovesomeofthisrandomnessord .suld have gone either way, 16l i 17 More recently, Mr. Shome and I did conclude l
l 18, that it was probably better to use the three year but that
, 19 is a j udgment call. We could have used a five year and it l
20 ' would not have made that much difference.
l 21 In the ultimate application of it, in 22 deriving a rate of return on equity, an estimated cost of I 23 equity, we would be talking about a cost of equity of some-24 where, today, in the 18 to 19 percent range. It could be
'J l 25 from 17 to 18 . We might be talking about a percentage l 17132 e MOHRBACH & M ARSHAL. INC. - 27 N. COCKWILLOW AVE. - H A R R LS B tJR G, PA.
~
Er4 @ ~-croce _
1289 i{ point difference but it would be up in that range regards.ecs h 3 I
of which one of these methods we would use.
i 3! Tney are all consistent and they are all '
4; going to give numbers somewhere betueen 17 and 20 percent.
5l That may look like a wide range but that is t
6f the way it is.and the data that we have got in the most receny 7 one, namely the testimony, is the one that I think we have 1
8l more confidence in.
I think if somebody goes in and looks at the 9l 10 numbers and looks at how they were calculated and goes step i
y,1 ; by step through the book and then going on to the Appendix, i
12 the conclusion that one would reach is that the Appendix 13 reflects better research.
14 The discussion over in the Netherlands on 15 that was by Professor Myron Gordon, who is the originator of 16t the DCF, the first one who has applied it, in cost of capital l
l 17 i studies, and he was discussing and pointed out things to us i
18 in the process of discussing, made suggestions and reconsen-i 19l dations, and we have incorporated those into the testimony I
20! today.
31 i -
22j (Transcript continued on next page.)
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Brigham-crsss 1290' r
I 1[ Q on page 16 of your testimony, Dr. Brigham, O i 4 f three lines on the botto:q you state the average electric f
3'd utility stock is now about as risky as the stock of the 4[r larger industrial companies, is that correct?
5i A Yes.
I 6l Q Would you agree with aa, Dr. Brigham, for .
7'; the record that the Merrill-Lynch adjusted beta as of I
8fOctober1980monthendfortheDowJonesindustrialindex 9
was .76. -
10 3 7 .lon' t have that data; but that would be ,
I want I 11 consistent withhierrill-Lynch has published in the past. i 12 Q Okay, and from that same publication,
-L 13 i would you accept subject to check that beta for the S & P S
)
14! 40 units as of month end October 1980 is .71, Merrill-Lynch?
15 k A I have no reason to doubt the numbers that 16 you are reading now. I would question the relavance of it.
t J l
17 j I understand that. I am just asking you, Q
18 l sir.
19 )' ; Would you accept, subject to check, l
l
C '
~j Dr. Brigham, that the Merzill-Lynch beta for month end I
21 October 1980 for the New York Stock Exchange Utility Index i
22 is also .76?
i 23 !
A Yes.
b M Q Dr. Brigha:2, if one was given an estimate
'5
~
of the risk premiums, how should one proceed to the level of I r.scwasAc:4 a MARSH AL. INC. - 27 N. t;eCXW1LI.OW AYE. - du ftR 5DURG. PA. 97112 l
^
i Brighac-cross 1291 l
1! deriving the individual company risk premium?
I he.
- 2l A If one were given the market risk premium?
3 Q Yes, I am sorry market risk premium.
.h
+f i A I think one would apply judgment. It would 5 be a judgmental application. One would form a judgment as to 6 just how much riskier a particular company was, more risky 7( or less risky a company was and different people would form different judgments and reach different conclusions about 0l 9 that, u
10 And Dr. Brigham, what facts would one Q
11 ' want to consider or .' _ok at in arriving at that judmental 12 conclusion?
h 13 i
A The kind of facts that would be reported 14[ in the report such as Value Line. You could take any 15 particular company. The kind of statements that are made by
{
16 those analysts would reflect the kind of information that one
~
l 17! should consider.
18 Take the case of GPU. The verbal 1:' , statements that are made, but different companies would ha ve 1
20 different risks, different factors that were impacting on 21 ,
the companies' risks. Sach company would have 'its own set 22 of factors that would influence its risk.
23 And, sir, what are the two measures of q
24f risk detailed in Vclue Line?
25 A Well, there are a lot more than two U p noma,cu a uansm. me. - 27 u. i.ocxwsuow aw. - : amnisatino. ra. $7si
/
l Brignan-crocs 1292*
I 4
0 l 1j measures of risk. Value Line reports somethin' called 3 timeliness which they give the primary weight to. In the
] which 3 l case of GPU, the timeliness range is five/is the lowest Ir 4 p' range and value Line believes that compcnies that are more 5 l timely will be the ones that are most likely to be bought and i
i 6l the ones less timaly are the ones most likely to'be sold by l
7 d investors, so value Line would suggest that if you bought 2 N
8 i company with a load timely range and five being the loweat, 9h that you would probably not do very well on that purchase .
10 ' Then they have another one called the 11 e$ safety range and they report a beta co-efficient and they I 12 have the companies' financial statements and then they have
{ 13 ; stock price stability and then they have price growth 9
h 14 ! persistence and earnings predictability and they make a 13 verbal statement in words. In the case of GDU they say 16.i, GPU shares appear to be too risky for the particular utili y i 17 ! investor and they give a lot of words as to uhy they think it t
18 is too risky, but they have these quantitative numbers, and 4
19y as I indicated, they are a total of seven of those and than d l 20 j they make some words.
3 .
21l The quantitative numbers tend to be based 22l on what is happening in the past. The words tend to reflect 23j what they think might happen in the future, so you are asking i
24 e question that they are not two measures of risk that Value g 23} Line is talking about. They are talking about at least seven McHRSACH O M ARS)4AL. INC. - 27 M. COOKi. grill 3W, Avt fi AR F.15 CUR G. FA. 17912
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Brigham-cross 129.1 1 plus the qualitative statement that they make in words on 2! the report.
3, Q Now, Dr. Brigham, in tha book that you 4[ have before you which is Risk. Capital Coats and Project 5' Financing Decisions, if you could, turn to page 99 please and 6l over to page 100.
at 7 '-- At least/the time that article was written, 8f and I understand it predates the appendix, as I read that 9( section on individual company risk premiums you and 10 Mr. Shome's methodology, as I understand it, you grouped 11 ' the S & P 400 company risk classes on the basis of Merrill-t 12 i Lynch adjusted betas, is that correct?
t h 13 I
A Yes.
l 14 -
Q You applied the average. beta for each
! 15 ! group, the 78 moving average risk premium, to obtain 16! estimated average risk premium for the year, is that correct?
17 [ A Yes.
13 lI Q And I believe there were two more steps l
l 19! that followed. You added the current yield on US Treasury 20 Bonds to the group risk premiums and you decided where a 21i company lies with respect to the risk spectrum and you used
! I 22! the average cost of capital as an estimate of that firmh 23 estimate, is that correct?
j
@ 24 A That is correct.
25' Q Now in your preparation testimony for this 97112 --
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case you have not followed that methodology, is that correct, 3
Q in arriving at individual company risk premiums?
3I A Tha t is correct . We now have available 4
Value Line data so we are incitned to use the value Line 5I data, although if I didn't have the new material and I think
. t 6-that the information given that you are quoting from is not 7
bad data, and if we applied it to industrial ecmpanies using 8f what we did, I think we would get resulta-shat were really 9'
remarkably consistent with what we get now using the present 10 methodology, but I think the present methodology is i
11 [ preferd;ile but the methodology I described in the book ir I 12 j relatively consistent with the presdnt methodology. j 13 ,
w J Q Well, I am a little confused, Dr. Brigham, h 14j I was under the impression that you did not use, well you 1
15 L certainly didn't use the Merrill-Lynch adjusted betas.
u 16 i !
A When you didn't exactly follow the same methodology in your i 17 I article in the ree.;ent book, but you said you used value Line 18li and you used value Line betas in your methodology.
I 19 A No, na . We are using enly aggregate ducail 20 as we were in the article in the book, just only aggregate l -
data. We don' t have risk premium on individua 1 companies so 31l I 22! we have got to use the market average risk premium and then 23f we have to make a judgment as to how much above or below the 24 J 25 market risk premium, what set of numbers we should apply to $
the individual company and one procedure that can be used, l
_ .mx. m , - c.-.. ,,. _ _ ., m - ,..,. ,,, m _ i
/
Brigham-creas 1295 l
1 and there could be other procedures, but one procedure that 2 could be used, if you were talking about industrial stocks i 3l as we were in that article, would be to use the beta 4 $ co-efficients, the use of CAPM approach, and if we did that, 5l that we would get those market risk premiums that range from i !
6 [ 4.9 at the low end to 7.3 at the high end using the capital i
7i asset pricing model approach. ,
8[ If we have data on individual companies 9 l{ relatively stable analyst projection data such as the Value 10 Line data, then we can go directly to the individual 11 l companies on DCF return and risk premium. We are able to i
12 l do things that we just simply could not do at the time we
] 13 l t
wrote the article in the book. .
.14 ! The article in the book, I believe, i
15 ! represented the best methodology that was available at the 16l time that article was written a couple years ago and I think 17 it gave results that if applied in this rate case would be t
16 l)l reasonably consistent with the numbers that I had developed -
19 ;
- in this rate case.
t 20 I think the numbers that were developed 21i in this rate case one could have more confidence in.
22l' You know, if you went back to 1965 or 1970 23 l4 and got things that I and other people had done, you would get i
Q 24 very different things, too. I think over time there is a 25 h tendency to come up with better research and have better N uonnica a urasuru me. - a n.secwu.i.ow m. - +tanesevaa. m mu i
Brighan-croce 1295' l 1
i 1 ! methodology and that is simply what we are doing and you are q
v 2, i
comparing something that way done a while back was something g
~
d 3i that was done now and I think what was doca now is somewhat 4; difderent than what ac did a couple years ago and I think it 1
5 ) is what is better.
6lj Q Dr. Brigham, your current testimony and 7; your current methodology, if we can say that for recommanding 8* the risk classification, where do you put GPU insofar as the 9 relative risk classification is concerned?
10 A Highest.
11 - Q And your testimony is of one used the e
12 methodology from your article with the Merrill-Lynch betas,
( 13 t
that GPU would come out in the same classification? h 14 ] A No. I think that it has been demonstrated 13 3.1 over'and over and over again very clearly and even by j i
16 Mer-ill-Lynch people that betas, historic botas such as the ;
. j.
17 ',3 ones Merrill-Lynch reports , can' t be usad in rate cases ,
t 18 Merrill-Lynch people published an article Public Utility i
19 h Fortnightly in February 1980 entitled " Utility Stock Market I I
20!j Regulation Risk in Beta"and the conclusion was that betas 31{ are just simply not a good measure' of risk for a public 22 utility and the book that you are quoting from, the article 23 - Mr. Shome and I wrote, we never applied beta ec-efficients 24, in capital pricing asset models for utilities. Youcouldnot'$
25; use the beta co-efficients for GPU or some other utility as a b .uowns aca a r. tan stuL. inc. - 27 N. L3 3MWILLcW ,WE. ~ N.RTUSSUftG. PA. tm2
Brigham-cross _. 1297 i
1 valid measure of risk.
I 2 You can calculate it and Merrill-Lynch I
3l calculates it and they report it, but their investment t
4} analysts, such as Mr. Leonard Hyman and Mr. Joseph Egan 5t certainly conclude it should not be used to estimate cost of 6l equity for a utility. I didn't do it before and I haven't t
7j done it now.
I 8{ Q To the extent we are discussing the 9.! S & P 399 in your article, if you would look at page 100 in l
10 your Table 6 in that article, it lists premiums by risk 11 . groups. Do you have an opinion if that methodology was 12 ! applied to GPU what risk would GPU fall into?
I
] 13 {
i A Well, as I indicated, that methodology l
14 l could not be applied to GPU because that methodology is 15 applicable only to industrial companies and GPU is not an i
16 h industrial company, so it could not be applied to GDU, so I
17j you ask me what would I--you are sort of asking me what i
18 l would I do if I _did something I think ought not to be done I
19 I that I have never done, l
i i
20j While you are looking at that, I will just 21 , quote from the Merrill-Lynch article.
22 "Our conclusion is that the currently 23 fashionable sianple approach to risk analysis which uses a I
y capital asset model beta has dubious value in utility 25 regulation."
a _ _. ,. _.-_ _ _ m- _._._ _
l
\ -
Brigham-cross 1298 s
l 1! That is the bottom line conclusion that
~
2 / Merrill-Lynch people have .ccme to with regard to using $
i 3! betas in utilities for utilities.
4 Q I am sorry, I don't recall there being an l
5l outstanding question, Your Honor. Dr. Brigham, are you 6 familiar with how value Line utilizes beta information?
i ? I I am sorry, recommends how beta information should be used?
f 8 A Yes.
l the 9> Q Would you briefly state that for/ record?
10 ; A Well, Value Line makes a statement to i
li j the effect that betas should be used as some reflection of the 1
12 i risk to a company or a company's stock if the investor holds
{' 13 i
the diversified portfolio. h Q Now, Dr. Brigham, in regard to your non-1 14 l l
15 l constant DCF growth model. It is true, is it not, that in i 16! your application of that model you utiliza value Line l
projections only to 1984, is that correct?
17 l
\ i 18 i A That is as far as I project, yes.
I i 19! Q 1984 actually is an 1983, 1985 average?
j 20! A Yes.
21! Q Now on page 39 of your statement, I
22 Dr. Brigham, the last two lines, you say since the forecaste:I l-23I ROE return on equity increases from 2 percent in 1980 to
, i r]( 24 8 percent in 1984, which is the Va1.ue Line forecast for GPU, h 25! it seems reasonable to assume a continued recovery in ROE, is McMRaACH 4 M ARSHAL. INC. - 27 ti. LOC)CWnLLOW A7E. ~ 7tARR.199UMG. PA. iftl3
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Brigham-cross 1299 I that correct?
2' A Yes.
3 Q Now I am making the assumption, sir, that 4i you actually haven't conducted any formal written studies i
5l t estimating the reasonableness of your fact. That is your 6 opinion giving your overview of the situation.
l Well, as indicated on page 40, I state 7f A 8 the assumptions that I used when one makes the forecast, one 9' makes assumptions as the basis for that forecast and the i
10 ; basis for my forecast is stated on page 40.
11 ' q And indeed for the balance of the years i
12 i from 1984 through 1989 then you have projected a return on m !
Q. 13 j payout ratios at a level higher than the value Line estimates 14 ;
prior to 1984, is that correct?
i 15l' A Well, as I indicated, the forecasted i
16! return on equity is 2 percent in 1980 and it increased to i
17l 8 percent in 1984 and since there is a trand that is operating I
18 and since 1984, the 8 percent would be far, far below the i
l> !
. forecasted rate of return for other utilities. I did extend l
20'; the time horizon out to 1989 and assumed that the return on i
21i equity would move up to the current industry average which is 22 12.7, which is still about 5 percent below the current rate 23 on investment grade public utility bonds. It seems like a
- relatively conservative forecast, but the assumptions of the 24{
1 25l forecast are stated there.
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Brigham-cross i300 f
1l t Q Just as a fact of the matter, Dr. Brigham, 2 thyoughout the testimony you make some statements, I believe, h i
3 to t.he effect that the way uncertanties regarding GPU in t
4! particular and TMI will unfold will affect the cost of 5; capital of GPU and its growth.
6 I guess my question to you is: Do you make I
7l any assumptions in moving beyond an 8 percent return rate, i
8l for instance, after 1984 as to the disposition of Unit 2 at i
9! Three Mile Island?
10 ! Is that something that you have to factor I
11 l in your judgmental process in moving up to an industry i
12' average return?
( 13 A The thing that I am moving up to is an g 14 f industry average for 1980 and not a projected industry 15l average for 1989.
16 3 Given the way things seem to be developing, i
17i one would expect that the industry average rate of return 18 l in 1989 would be considerably higher than 12.7 percent.
I I 19 , But certainly TMI-2, TMI-1, both, would i
20 S affect the company's rate of return, the rate of return the l
21 company earns.
22f There are just many, many things that' would l
23 I affect the rate of return. Those two things would be very O 24j important. But regulatory- treatment of those units, a lot' g 25l of things would have an effect.
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Brigham-cross 1301 1 ,
I am simply taking what seems to be a i
O~ 2 vetue tree eae erosectio= e=a lreeomedteere$eccte-3 ! stopped in 1984, then I made a projection extending it ou out 4 I beyond that that seems to be reasonable in a trend projection 5 sense from what Value Line is doing.
6 I But the numbers come out when you do that, 7, and I updated it yesterday using the current stock price 8l which is 4.375 down from 6.25 -- and you get numbers of i
9i 23.9 percent as the cost of capital using that procedure 10 with the current stock price. 23.9 percent is a high 31 ; number.
12 You can moderate the assumptions that I have
- 13 used considerably and still have a rate of return that is 14 20 percent or thereabouts.
15l Q From your answer, Dr. Brigham, in your 16 I judgmental process in moving beyond 1984 have you made any i
17l assumptions in regard to the availability of Unit'No. 2 and 18 its inclusion in rate base?
19 i A Not explicitly. The numbers that are given 20 here don't explicitly state what would happen to Units 1 and 21 2 over that time period.
l 22 There are just too many possibilit-tes to make 23f that kind of a forecast, I think, worthwhile.
24 Put another way you could make an infinite 25a number of forecasts.
I e ,.io m ca o mn e m . m - = n. co m m .v, m . p m .u,,, ,,,,,
i
Brigham-cross 1302 I
1j That is the reason in this case I think it g, makes more sense, as I indicated in the testimony and in the Ihk summary this morning, I think it is important to look at what 3l 4l the costs of capital are to other utilities operating in this t
5l area, what their costs of capital are, because you can get a 6f much better handle on a reasonable forecast, a forecast that 7' ,
analysts are actually making, and then make inferences as l
9[ to what the cost of capital for GPU would be based on those i
reasonably comparable companies.
9 ll Q Now staying with your non-constant growth 10 j' l
11 l approach, using Value Line data, Dr. Brigham, I believe on 1
i I 12 i Page 32 of your Appendix A you acknowledge the. fact that the I
{} 13 f use and validity of your non-constant growth model is lll 1
14 ! critically dependent upon whether or not the value Line l l l
15l analysis is representative of the views of investors in I,
16l general, is that correct?
17i A That is correct, and because of the 18 importance of that we have studied the correlation between i
19 Value Line forecasts and forecasts made by other analytical
, 20 f groups and I think I supplied that as an information request.
l r l t l 2i j It turns out that Value Line is very close 1 t.
22l to the middle of the range of what other analysts are t
forecasting.
23f i
24l So that caveat expressed in the appendix (g) 25i still exists but now we have data that suggests that Value i 17112 noMR8 ACH & 84ARSH AL. INC. " 27 N teCWynaSW AVjt. - j AA9;SS1JMG. PA.
/
'? '
Brigham-cross 1303 Line is indeed a representative forecasting organization, 1l h 2 MR. BURGRAFF: Can I have the last answer, 3f please?
4l (Answer read.)
5 BY MR. BURGRAFF:
i 6I Q Dr. Brigham, in that regard if I recall --
7 and I'm trying to recall the testimony -- have you conducted t
8 i any written studies which show whether Value Line can or 9 cannot be viewed as representative of the market at any i
10 particular point in time?
11 l A Yes, the working paper that I supplied to you i
12l as an information request entitled Value Line Forecasts i
13 Versus Other Analysts' Forecasts by myself and Mr. Steve
,14 ! Vinson, of the University of Florida, did deal with that and i
15l did conclude that Value Line is representative.
In the study supplied as an information 16l i
17 l request we also cited an article by Brown and Rozeff which 18 h was the lead article in the Journal of Finance, May,1979 in 19 which they made the statement -- they dealt with value Line, 20l dealt exclusively in the study with Value Line as far as 31 f the data is concerned -- and they stated:
22f "Our evidence of analyst superiority over i
time series models means that analysts' forecasts should be 23l p 24l used in studies of cost of capital until forecasts superior J !
25! to those of analysts are found." l 1
" monnaAcw a uAnsaAL. INC. ~ 27 N. I'.@CKWILLOW AWE. - g Mt Mid S UR S. P A. 17982
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l Brinham-cross 1304 '
1i They were talking about Value Line, stating O 2 i chet value tine made better forecasts than other procedures. #
3f We did look at a Value Line forecast for i
4! AT&T to quite an extent, because there is a lot of data 5: available on AT&T, we could compare value Line's forecasts I
6( with other forecasts for AT&T, and then we also compared I
7 Value Line forecasts with seme 189 companies that were 3! reported in the. Standard & Poor publication, Earnings t
9! Forecaster.
10 l So the answer to the question is that, yes, i
11 j we have been 1:oncerned about the use of Value Line as being i
12 l representative and the work that we have done suggests that Q 13 it is representative. h
.14 f BY MR. BURGRAFF:
13 Q Dr. Brigham, Value Line makes recommendations 16! as to stock purchases, is that correct?
17i A It makes recommendations as to whether or 18 j not particular stocks seem to Value Line to be good or bad i
19 ,! buys.
t 20' Q In Your opinion, does Value Line have a good 21! track record in their reconcendations on certain stocks?
22i A The evidence that is available suggests that 23l value Line does have a relatively good track record. There
'i 3 24l have been at least three papers on that subject, probably g W
25i more.
" MOHRB ACH & M ARSHAL. INC. - 27 N. Et,CJCWALOW AVE. - g A R RIS B U94 G. P A. 1711E
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~ '
s Brigham-cross 13n5 There have been two publications and then s
l 1 2 there is a doctoral dissertation that.is either finished or 3f is in the process of being finished. I heard a talk on it at 4l a recent finance association meeting.
I 5l Everything that has been done that I have
}
6i seen indicates that Value Line performs well.
7! . Q Therefore, Dr. Brigham, would you agree with F
gf me that Value Line is smarter than the market in general?
9l A There is some evidence that suggests that if 10 l an investor followed Value Line recommendations they would do
.n. ,
! somewhat better than they would do if they just bought the i '
12 j market in a random fashion or bought the whole market.
l
)
13 , I don't think it is overwhelming and I don't l
.g4 think that investors would probably do a whole lot better.
15; But there are some 85,000 people who buy 16i Value Line and pay 300 and some dollars for that, and more
- 17. than that that use it in the libraries, and apparently those Igf people would not keep coming back and buying it if they did 19; not think it was of some value.
i.
l 20i Q Dr. Brigham, are you aware of any earnings i
21 ! growth rate estimates that go beyond 1985 that are made by 22 - any security analysts or portfolio managers or investors that 23 you know of?
24 A Yes. Wells Fargo, for example, I believe, 25 forecasts out 15 years.
I wowmen a uusxAs me. - 27 n. c.cxwm.ew Ave. ywssm. ex. ima
/ .
l .
Brigham-cr@ss J 9M I
2 rirst National Bank of Boston I know forecasto O 2 ! out for at teest to 7 ears- outte a rew- :#
i 3 Again, I think in the information that I i supplied you in the data request, the answer to data request 4
5 No. 74, I gave you copies of materials that had been put out i
l 6j by a number of organizations that extend out beyond 1984.
I I
? So, yes, some forecastors do forecast out l i a' beyond 1984.
I l
l 9l Q Do you know offhand what Wells Fargo's 1 t gross estimates would be through 1989?
10 l l 11 l A For GPU?
^
l
- 12 , Q Sure.
{, 13 A No, I don't. g j 24 [ Q Would your answer be the same for First 9
13 f! Netional of Boston?
16 A Yes, it would.
17' Q Do you have any knowledge, Dr. Brigham, of 18 any estimate by any group beyond 1985?
A I have not been able to locate any.
19 h 20i Q Dr. Brigham, in past testimonies you have' l 21 made use of the comparable earnings technique, have you not?
22! A The first time I filed testimony I believe 23 h that was the only method that I used. The answer is yes.
24 I have not used it in the last year or two. g 53lt Q How do you decide whether or not to use MOMRSACH ik MARSHAL. TNC. - 27 N. L@CWnLLOW AYE. - ' JAR RISBVRG. PA. _17112 1
l .
' Brigham-cross 1:07
, 1! comparable earnings?
l 1 l
h 3{ A I used it when I did not have very good 3
I market value data to use, and when the comparable earnings l 4, method seemed to be the primary method to use.
i 5[ As I have developed better market value I
6l techniques I have simply stopped using it.
I I think if you look at the testimony filed
?l ;
8i in the 1950's practically that was just about the only thing.
9l We did some research on it and we found the first time we i
find 10 t could/anything other than comparable earnings was when i
11 f Professor Gordon filed testimony in the AT&T rate case in i
12 the mid 1960's.
13 Then more recently as we developed our risk
)
.14 f Premium measures and that kind of thing we have tended to i
15 use other methods and get away from comparable earnings.
16 I think nowadays there is a tendency to not l 17 i use comparable earnings.
I Q Perhaps quickly, Dr. Brigham, you could just 18 j 19 [ briefly just state for the record how you applied comparable 20( earnings or how you used it.
! o A You mean back when I did something I don'n 21f 22, believe should be used any more? What did I do back when I f
23l - did it?
i 24 Q That is right.
)
25l MR. RUSSELL: I don't think this is h MOH NCH & MARSMt., INC, - M N. CMKWIW.eW AVE. pamSSUMG. M. Im2
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i
- i. - - .-----. ,. ,- --. - - .. - ._,..- ,--.-,,-.-- - . - - - - . . - . . - , . - - - . , . -
f' Briaham-cross 1308 t
i 1! cross-ernmination of this witness with respect to his i
O 2! teselmony.
Thie is not any part of his teseimony that is G 3! before this Con: mission so it is not relevant.
4 MR. BURGRAFF: Well, Your Honor, I think it 5l is relevant from the point of view of the witness has used Gr the orocedure before. He has stated he has not used it in
- 7. !
this case.
8f I think it is relevant to know how he r
9! applied it and then we can take a look at it ourselves.
l 10 .i MR. RUSSELL: How he applied a method that 11 < he has not used in this case and has not used for a period 12 f of years?
{ 13 j MR. BURGRAFF: How he applied the method g i
14 ; when he used it, i
15' THE ADMINISTRATIVE LAW JUDGE: I think it 16 is relevant cross-eramination, if he applied it before, and 17 the reason why he is not applying it in this case. We will 18 l overrule the objection, l I used it two ways.
19 ) THE WITNESS: One, I 20; N
looked at the rates of return that were earned on average 21 !! book equity by a group of utility companies as being the 22l group that was most comparable to a particular utility l l i 23 !
ccmpany. /
g I looked at that but I never really used it 24l, 25; and relied on it at all because it is obvious that if you MOMRSACH e NARSHAL. INC. - 27 1 EA>CXWII. LOW AVE. - p A R Ris s ua G, P A. 37112 l /
L
Brizham-crocs 1309 g {do,iftheotherutilitycompaniesarenotearningthecost h') 3 I
i of capital, there is a difference between the return that 3 , the companies are earning on book equity and the true cost l
4 ; of capital, then the average rate of return that a group of 1
5 ' these utility companies are earning is not a fair rate of 6 return for the particular company in questien to earn, y; It is kind of like looking at a group of i
8' patients in a hospital and say, well, the average temperature 9j is 103 and that must be normal.
~
i 10 l You have got enough sense to know that that
\
gg l is not the case.
12 , Similarly, we know that if a group of 13 utility companies are earning a rate of return on their 14 equity which is substantially below their cost of debt, we 15! don't know what that rate of return is but we know what it 16i is not. We know it is not the cost of capital to the
- 17) c mpanies. They could not raise new equity capital with i
18l investors expecting to get a return equal to this return on 19 book equity which is below the cost of debt.
I 20j So I looked at those numbers and I rejected 21( them.
22)!!
Then I also looked at the rate of return on 23] book equity for industrial companies and those numbers were l yl more reasonable in that they could not be rejected out of IO i 25j hand as not being equal to the cost of capital. But I was i
" FAOHRBACH & MAftSHAl INC. - 27 ft/1;ScKWmt.7N AW - y AR us e LF9 G. PA. 17112
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l .
Brigham-cross 1310 i
never able to come to grips with two questions. I
,l \
'] 3} First, I was never able to come to grips h' i with the issue of what set of industrial ecmpanies is 3
i comparable in risks, comparable in a manner that I could 4 :
i i defend in a proceeding such as this, 5 t i i So I 1 ked at those rates of return on book l 6}
' ~
equity for the industrial companies but I really did not know 7
I 8[ what to do with them.
The other problem that I had with that is 9
i i that the industrial companies were typ'ically selling at 10 f l g prices above their book values which would indicate that i
12 ; the rate of return that industrial companies were earning on
] 13 f the book value was something in excess of the cost of g l
yj capital.
33j So I did not really think that the rate of l return that industrial companies were earning on the book 16 equity w s their market value cost of capital, either.
17 18' S I got those numbers and I looked at them 39 l and to the extent that I did not have anything better to use- -
i .
l 20L which was the case the first time I filed testimony I think l i 21; in 1968 -- 1 put them in and I worried about them, but ,
g nobody else said anything about them.
l Subsequently, fortunately, I have gotten 23[
p p
n better procedures and I have applied those in this case and g
25l I did not use comparable earnings and I have not used it in MCHRBACH & MARSHAL, INC. - 27 Nc EGCXW1LLCSV AVE. = >* ARRISSW5tG, j PA. 17392
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I l
Brigham-cross 1311 l
1 1i i several years.
h 3f l
Q Dr. Brigham, just hypothetically, in your 3 ) comparable group of electrics, _f that comparable group had i
4 I a market to book ratio of one, would your reservations you i
5! have expressed in regard to a comparable group of electrics 6l still hold?
l 7l A Yes, because the return on book equity is 8l the realized rate of return that tne company earned in some 9i past period, and the cost of equity capital is an expected 10 rate of return that investors have for the company in scme i
11 ' future period.
12 ! It is very difficult to find any period in 13 the last decade where investors expected companies to earn 14 f in the future the same rate c E return that they earned in 15l the past.
i 16! The rates of return of different companies l
l l 17, have tended to be relatively unstable. It has been a 18 j tendency in the unregulated sector for rates of return to 19 I move up, strictly because the cost of capital is moving up l
j 20{i and the companies have to have a higher rate of return to 21j. compensate investors for investing, and they are not taking 22 on capital expenditure projects, they are not making 23l investments unless they can get higher rates of return than 1
24! historic rates of return.
25 So I m uld have reservations under almost t"-
woNns4Ca a uAnSMA1 INC. - 27 N. ESCKWtu.eW WE. PMSSUMG. PA. fm2
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Brigham-cross 1312 i
any conditions about using the comparable earnings approach.
1l C 2
' And most importantly, I don't think we need g to. I think we have market value approaches that are 3
t 4 i conceptually better, easier to implement, more accurate data i
5: comes out of them.
i 6i Q Turning to Page 45 of_your statement, P
i i 71 Dr. Brigha:n, the formula that you use for your one percentage I
8i point adjustment for various expenses and market pressure --
gI do you have that, sir?
~
i !
10 A Yes.
Q The equation at the botton of Page 45 that 33 12 ! you use in arriving at your one percentage point adjustment
( 13 t ignores the present price to book ratio of the particular g 14 l firm, in this case GPU, is that correct?
, t 13 A It is not a necessary input for the equation so in that sense it ignores it.
_16 !
It does not ignore it. It is just not in 17 l I
14; the equation.
i 19 [ Q Well, it is not in the equation?
A Yes.
l 20f 21 Q Dr. Brigham, isn't it correct that you have 22} in the past used a statistical model for adjusting price to 1
23; book ratios?
- ! A Yes.
24l, In fr.ct, I believe that you used a statistica l 23 Q r,u wowauca a unsuai me. - 2c n. eacxve.u.aw ws. p.aaissun.. ,*.
/
Brigham-crose 1312-A a
f Il i model in the Georgia Power case we were discussing earlier, h 2{
3129-U, do you recall that?
3f f
4:.
I 3!
i (Transcript continued on next page.)
6l l T ai l
9!
10 ! -
11 I i
13 i
.14 15l 1
1 16!
- l 17 !'
18 19!
20!
i 21!
22!
23 l.
1 i
i 25 MQHRBACH & MARSHAL. INC. - 27 N. LOCKWILLOW AVil . p ARR199URS. PA. 37112 i
l l
l
Brigham-cross 1313 l
- 1. A I had it as an appendix ar.d the use that O
b 2l I made of it was gr aarily to get the mariet-to-book $l!
3 adjustment that I have now developed the analytical approach 4 ,
shown on the footnote of page 45 of the tutimony. T hat f
5f ;
model that I used was not necessary. It ended up concluding-6i that it took 30 to 40 pages to do something that could be t
?! done in a half a page.
h 8'
THE ADMINISTRATIVE IAW JUDGE: Let's take i
9 a 10 minute recess.
I 10 (A short recess was taken.)
11 ; BY MR BURGRAFF; I 12 f Q Dr. Brigham, you have, beginning on page
() 13 a
11, a section of your testimony concerning changing h 14 f investment risk, as you define it, for Met-Ed,'Penelee and 15 ; other electric utilities, correct sir?
i 16! A Yes.
l 17 And you pose the opinion that where l Q I i 18l average electric utilities today have about as much investment 19 risk as large industrial companies and you list s 'mber of 20: reasons for that, is that correct?
21l A Yes.
i 22f Q I believe your first reason is basically 5
23 regulatory lag affects utilities, is that correct sir?
O 24i A The one headed inflation? $
~5j Q Yes.
9 WC. - 27 N.- t.4CXWIW.OW AYt. - W ArttHSsurtS. PA. m12
.MOMRSACM & htARSPAk
/ .
3righam-cross 1314 t I I f A Yes. The industrial companies can and do' a
- set prices on the basis of expected costs and utility prices 3l after rate proceedings essentially on bistoric companies and 4; inflation of the reguLitory lag phenomenon does have a negative impact on utilitics rather than industrial companiest.
5l I 6! Q Dr. Brigham, does the test year selected l
7l i by a company as the basis for selecting rates impact the 3 degree to which a. utility company will be able to recover 9! all its actual costs?
10 ; A Well, if a utility company could use a 11 ;$ test year where the cost in.the rate case, chose things 12 were the average forecasted level over the period when I
C[ 13 l rates would be in effect, then that would in essence put i
14 l utilities in the same position that industrial companies 15, are, but in my experience, companies that could use a 16! " future test year", it really is not a true future test year.
1 ;
l 17 It really may be a future test year at the time the rates 18i are filed, but it is not a future test year when the rates 1 ,
19 are collected.
I 20 W Q Dr. Brigham, I understand you are t
i 21! discussing a rate yeer and I would agree with you that the 22 '
rate year would be a perfect match, but the question was 23 ] does the test yese select and impact to the degree to which iCh 24; the utility company can recover its actual cost, would you i
25! agree to the actual cost?
woun.4cw a mAyMAL. WC. - D NJ ESCKWM.OW Ad. - MMr#.3. PA. mu
l l
Brighaa-cross 1315' l
l
~! A I would agree, f l
b 3 k
! Q And some jurisdictions require historic l
3 f test years, is that correct sir?
, l i
4l o A I think they all ultimately use what amounts to historic test year. Soms go back further than 6
others.
7-
, ; Q Well, but some jurisdictions permit the 8l' !
filing of forecasted test years, is that correct?
9 i ! A Tha_e is correct.
l
' 10 l And to the extent of your knowledge, does
, Q 11 l Pennsylvarta permit f.he filing of forecasted test years? ,
l 12 '
I ; A Yes.
h
^
( 't 13 Q Dr. Brigham, do you know how long I
l 15; utilities in Pennsylvania have been able to file forecasted
~
..l
- { test years?
16 ',
l A No.
ll i
17j Q I would like to refer you to page 12 of 18 your statement H, Dr. Brigham, particularly in regard to 19 your discussion of increased forecasting difficulties as a 20i risk factor 21l A All right.
i l 22! Q Would you agree that plants that are l \
23f going into service today by and large are based upon i
_; 24f investment decisions made somewhere around 1970 as a , general h 2.,
rule?
U-- uonacAca a m ArtsnAL. inc. - 27 nc .ecKw.LLow AVs. - AAPRISetJM. P/ 17112 l
Brigham-cres s 1316 L
i 1> A Yes.
2 Q And do you by any chan:e have any 3 documentation available to you that w;ul Indicate what the 4f market-to-book ratios of the Moody's 24 electrics was ao 5 average in the 1969 through 1971 period?
6 A Well, I have a return on equity for the i
7l Kompustat electrics which is a more inclusive group than the 8! Moodys' 24.
9i Q I need market-to-book ratios.
A Well as I say, I have it on Schedule 1, 10 l 11 l page 9 in my exhibits. I have market-to-book ratios for the l 12 utility industries. You asked about a sub-group of ,it. I C' 13 ! don' t have that sub-group. I have a whole industry, v
14 Schedule 1, page 9. ,
i 15 l Q And looking at Schedule 1, page 9, would i
16[ you agree, Dr. Brigham, with the 1969 to 1971 financial clinpte i
17 l for electric utilities would have encouraged investment?
18 A Would you repeat that please?
l !
19 i Q Yes. I said in looking at your Schedule 1, 20i page 9, would you agree that the 1969 to 1971 financial 21 climate for electric utilities would have encouraged 22 investment?
23 A Yes. I don't know if encouraged is really 24 the proper word. It would not have discouraged. I think if v@s 25 the investment was made an the basis of projections of demand MCHRBACH & M ARSHAL. tHC. - 27 N/ LOCKWILLOW AVt. - JARR.ISBtiftG. PA. 175f2
Brigham; cross 1317' I
1 and the relationship between the rate of return that the o i
\
2 companies were earning andexpected to earn and the cost of 3 capital was such the companies had no difficulty financing, 4l so they projected their demand based on historic trend and 5f then they were able to finance the construction of the plants 6! to meet that demand.
7+ Q Do you know when the Job Development Tax l
8 Credit became available to electric utilities, and by that I 9 [ : man the investment tax credit which may no: be subtracted 10 l from rate base for rate setting purposes?
s li f A I don't know the year it was effected, no.;
Q Would you accept, subject to check, the 12 f 13 fyear is 1970?
A Yes.
14 f 15: Q In your opinion, does the existance of 16 this Job Development Credit serve to stimulate the deci2 ability ,
17j of electric utilities to make investments because, I guess, i
18 4 if everything else is done correctly the utility will carn capital as a result of the Job 19 ] more than the cost of 1
20 ] Development Tax Credit?
i 21l A Well, the Job Development Tax Credit would
- I 22! under conditions that have not existed for the last seven or 23 eight years, enable the company to earn more than the cost l
C" 24'
? of capital, but that has not happened since 1972, and also $l 25{ the Job Development Credit would, of course, provide cash and ti moxasica c. i.iinsuit. it - 27 n. cocacwistow Aic. - Aman:. una. ex. iriis i l
1 Brigham-croso 1318 i
i the electric utilities need cash'in order to carry forward 2i construction programs, so in both senses, the job development credit is beneficial to the industry and would facilitate 3l l l
- 4) construction.
5I Q Dr. Brigha:n, you would agree that the I
C 6i electric utility industry is a capital intensity industry, 1 I
?I would you not?
I Sl A Yes.
9 Q Would you agree that one accurate measure r
10 ; of the capital intensiveness of an industry would be to look 11 l at how many dollars of annual revenues are produced for 12 each dollar of an investment?
h 13 I i
A The ratio of sales to investment.
i 14 Q That is fine.
15, A That is one indication of the degree of 16 capital intensity.
I t I? l Q There are a number of potential feasible r
18 3 sources of generating electri' city that e:<ists today, is that 19,f correct?
i!
20l A You mean nuclear, coal, oil?
i 21l Q Yes, hydro-electric based on oil-peaking x 22;i units.
l 23 ! A To's fairly minor extent, that is correct.
Gas and oi l
] 24j There is not many hydro sites that are aval.lable.
1 ~
25j are pretty well ruled out by che federal authorities. Right
! MCMRDACH & NAltSHAL.1:4C. - 27 H. CGCKVf1LLOW AV'E. - AAftTtISBURG. PA. 17112
Brigham-croos 1319' 1
i now about the only alternative for a company is coal. I n',
- [wouldbemoreaccuratetostatethattheutilitiespretty 3 much nowadays have to build coal, that some time in the past 4 they had alternatives.
t 5l- Q They still have the option of peaking units, L
6j don't they?
i e,
- i A I suppose they can use oil for peaking e
j units to the e:: tent they need peaking units, but the whole 9f ,
thrust is through load management. I don't think there is t
10 ' very much potential for using oil.
'1 I q Q I suppose, Dr. Brigham, there are other l
12 f feasible sources that perhaps aren't cost effective now but b' 13 j perhaps in the future. h 14l MR. RUSSELL: Feasible courses that are l
15 [ not cost effeetive?
10 iI '
MR. BURGRAFF: At this point in time. I I
17 mean windmills, geothermal.
18 i
MR. RUSSELL: Are you talking about oi possible or feasible?
20 MR. BURGRAFF: I am sorry, possible.
21 THE ETNESS- Yes.
22f BY MR. BURGRAFF:
I f Q Now Dr. Brigham, does the capital
(, 24 intensiveness of a utility vary depending upon the type of 25 [ electric generation built and how that type of electric n
j uouss4Ca a ura,SHA1 WC. - D N. CCCMYnu.OW Ad. = AARTttsauRG. PA. 17112
l Brigham-cross 1320 1l generation is built and where that type of electric generation 2; is built?
3 A Yes.
4 Q And is utility management able to influence 5 which type of electric generation is built, where it is built o within limits and bow it is built within limits?
7l A Within limits, yes. The limits may be 8l fairly tight.
9 ,
Q Therefore, would you agree that even given 10 f a demand for electricity which must be met, utility management t
11 : can influence just how much investment capital is employed to i
12 ! generate that electricity?
hj 13 i A Within fairly tight limits, but to a f
14 much more binding constraint as the amount of demand and the 15: technology and cost of putting that in technology at a given 16 ! point in time. Utility managements have,to my way of I
17l thinking, fallen in a narrow scope for managerial decisions.
18! Q In fact, I suppose Dr. Brigham, it might l
19 even be possible in certain circumstances for utility 20 l management to set up an arrangement whereby it purchases l
21i power at zero investment cost?
I t 22 ,{ '
A To the extenc that somebody has surplus v
23 [ power to sell, but somebody has to build. the capacity.
l
. 24 Q Do you know, Dr. Brigham, aren't there i
25; soma electric utilities in this country which basically do no :
i-McHRsAcM e MARSHAt INC. - 27 H. L9CKWIL LOW AVT. " WAR AJSBtJRG. PA. 17112
/
Brigham-cross 1321' I
i 1l generate any electricity but purchase all that is needed for tl
-l its customers?
4 $
3l A I suppose. I don't know off-hand of any 4l others than municipals and co-ops, but I imagine there are i
5 some.
6k Q Does the research margin built into the i
7 y system design impact the total investment required for the 8l utility to serve its poorer customers?
9l A The reserve margin at the time of facility t
10 j planning?
I Q Yes.
11 f 12 f A Yes.
O 13 i Q Dr. Brigham, from your understanding oi 9
~
14 f the industry, is there an absolute number below which a 15 ? utility company should never see its reserve requirement i
16f deminished or is there a certain discretion on that?
i L
17j MR RUSSELL: Well, if Your Honor please, 18 this is a rate of return witness and be is being questioned 19 ' about what kind of reserve capacity a utility should have.
20 I submit this is totally beyond the scope of his testimony.
31 THE ADMINISTRATIVE IAW JUDGE: Yes. I I .
22; think you are getting out of the field of the expertise of s
23j this witness.
i
- 24l MR BURGRAFF: Well, if I could make one h 25 statement, this gentleman is testifying to risk of electric 1 uoHasACH et MARSHAL INC. - 27 N.- CoCKW&u.OW AVE. - 4A.ut* BURG. PA. 17112 i
Brigham-cross 1322 d
f Il utilities and bow it is now in his opinion approaching large 2[ industrial and he has listed a number of factors compdsir.g i
i that risk and I would just note that one is the fact that ,
3 4 utilities investment goes to increased forecasting difficulty 5l and also uncertain about fuel cost availability. These l
questions relhte to those areas.
6l ;
7; MR. RUSSELL: The percentage of reserve 3' capacity isn' t among any of the items that have been i
l 9( enumerated. It is an earnings issue. It is not a financial 4
0 10 i t issue. ,
11 MR. BURGRAFF: To the extent it impacts on forecast, I simply asked for his and my benefit. I will 1
12 f h 13 j t
try again.
TIE ADMINISTRATIVE IAW JUDGE: We will I
1 14 {
15 i overrule the objection, but I think it is more of a planning i
16 l problem and a matter for the planning experts rather than a i
rate of return witness.
17 l l 18i BY MR. BURGRAFF:
i i
Q Dr. Brigham, to the extent that there
, 19 l 20[ was an established, shall we say target level management 21! desired to see a reserve requirement,,wouldn't that impact on the investment needs at a point in time?
22 23 A Yes.
i Q 24l l
Q On the top of page 13 or near the too of 25l! page 13, Dr. Brigham, you state that high service rates
' McMRSACH Q MAR $*4Ab INC. - 27 N. CSC20W11.1.CW AYt. - WA%1t!SEURS. PA. 17112
1 '
Brigham-crose 13225 1l might cause customers to reduce their demand for power, is O !
2 ! that correct?
l9 3 '
A Yes.
4I Q In your opinion, Dr. Brigham, does this 1
5l cause a risk for the utility stock investors ?
0 A Does it cause a risk to utility investors?
7f t Q vell, shall we say does it create a risk?
8! A If utility customers had zero price 9, elasticity of demand, then there would be less uncertainty i
10 l about the extent to which companies could sell power that i
11 they are able to generate. It is just simply a condition. f 12 f (Testimony continued on next page.)
O 13 i G 14 i'
15i 16 I
I 17 .
18 19i i
20i l
21j s 22 l 23 O 24; e 25;
. mcx . opiu mc. - = u. .<=vnu.ow .v4. - A=oma. .-4. mu .
Brigham-cross 1323 1; Q Maybe a better way to state it, Dr. Brigham, i
ll() 3! is what would have to happen in this regard in order for 3' the reduced use to cause a problem for investors over and 4l abovo just a higher price for customars?
I 5! A Well, in a rate case the campany forecasts G a certain level of demand in terms of kilowatt hours sold 7t and they request and they are granted some revenue per 8! kilowatt hours sold to different classes of customers and 9l that will generate a certain amount of revenuas.
I 10 : If the revenues are not forthcoming during 11 f the period when the rates are in effect, demand in terms of i
12l kilowatt hours sold is less than had been forecasted and the 13 company will have less revenues and they will not earn the
- {)
14 f rate of return that had been thought they would earn. That is simply an element of risk. 15l 16l Q I still don't understand, Dr. Brigham, how I 17j that can be an element of risk. Wouldn't the company in 18 ! that case just simply file a rate case sooner than they I i 19i normally expected? I 204 A If the utility company could operate like an i 31l industrial company, and if their profit margin is down, their I 22li rate of return is down, simply do what grocery stores do, i 23 set their little stamps and go through and stamp all the 24 cans with a higher price, do that over a week-end and raise 7 (~u w the price so they are higher on Monday, then that could be do-ae. 35l h wownsACM a M ARSHAL. INC. - 27 N.1: SCC #1LLOW AV(. - H 4 R 413 S LM G. PA. 17182 i
1 n,<oham.rvn.. 1324 l i 1; Utilities don't operate that way, though. A 3I I ([) utility company sees a condition developing and it would 3! develop to a point where they can make a rate case and :: hey 4 l file for it and some months later they get a rate increase, 5 and during that period of time, during the long period of G time that the company was not making the rate of return,
?l stockholders are losing that amount and that is lost in 8 perpetuity.
I 9 Q Dr. Brigham, in your opinion do industrial 10 j companies generally raise their prices based upon drops in 11 , demand? 12 A Industrial companies set their prices in a (~) 13 manner that will maximize their profits and it depends on lll
,14 the situation.
l 13, We have seen this year automobile demand i 16! declining, automobile sales falling off, and automobile l I 17i prices going up. I 18 Companies strike a balance between rising i 19! costs trying to recover those rising costs yet not wanting
)
20 s to depress ~ sales anymore than they have to. 1 21; But industrial companies have the scope and 22 flexibility for adjusting prices in the manner they think 23l would best increase their profits. Utility companies don't 1 24 have that same flexibility. ggg 25 Q But the point of the matter is that a simple MCHMB ACH & MARSHAL. INC. - 27 N.- CGCMWILLOW AVE. - IfARRISetJMS PA. 87112
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Brigham-cross 1325 i 1 drop in demand does not generate by definition a price rise I r l
@ 3 by industrials, does it? For instance, Chrysler with their 3l current rebate.
l /, MR. RUSSELL: I think he has answered the 5 question. 6 MR. BURGRAFF: I believe the witness stated, 7i as I interpret his statement, he said not in all cases, there 0i are a number of factors. I 9i I just wanted to make sure that that was the 10 i witness' opinion and not mine. 11 ! THE WITNESS: Drops in demand tend to occur 12 f because something happened and the drop in demand that i 13 l occurred just recently has been a drop in demand that has 14 , been associated with high rates of inflation where consumers partly are reducing their demand because as the costs are 15l i 16 going up, to a large extent the cost of energy and products j 17! that are made with it, so in a ceteris paribus world where I 18 everything were held constant, your statement might or might 19j not be correct; but in the world that exists we have had in i 20l most industries, in many industries, declining demand and i 21! rising prices, and the increases in prices were caused 22i partly. because profit margins are down and those profit I 23l margins are down partly because of higher costs and partly ~ 24 because of declining demand. We just con't separate it out 25 the way that your question seems to suppose that we can. I' um.,en . m.m. me. - a n. comm.w avy. p==a. n. mu
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nrieham-r rissa 1326 i 1 Q Now, Dr. Brigham, staying on Page 13, is the {s. 2f Pollution abatement risk you discuss on that page a risk h 3j borne by stockholders or a risk borne by ratepayers? I 4l A Well, it is a risk to the utility, and until 5 .the particular situation develops it is not clear who is i 6 going to pay the cost. l 7I It probably impacts both consumers and I 8 stockholders. For example, a utility company might plan to 9 build or might have planned in the past to build a new coal 10 ; plant. They start building that coal plant then find they l 11 [ have to install scrubbers. The installation of the scrubbers 12 i causes the capital costs to rise dramatically. 13 Then when the plant goes on line the rates g
.14 ! have to be set to cover the total cost which would include i 15, the scrubbers, but that might curtail demand or reducec.
16! demand such that the company when they put rates into effect i 17l had a reduction in demand that kept the company from actually i l l 18 j earning the rate of return that was forecast for them to i 19 l earn, and so customers would be paying higher charges and [ 20l stockholders would be getting lower rates of return because i l 21 of the combination of attrition and regulatory lag. 22- So Probably that~ particular thing would be 23i borne by both customers and stockholders during the period. Dr. Brigham, do' you know how the. l 24 Q g 25l Pennsylvania Public Utility Commission treats pollution I
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Y
- Brigham-cross 1327 I
1 l control equipment during conscruction for purposes of rates? h 2 A No, I don't. If they follow the FERC 3 . procedure then they would permit it into the rate base, they 4 would permit CWIP associated with it into the rate base. 5 I don't know if they do that or not. 6 Q .On Page 14 of your testimony, Dr. Brigham, 7 , you discuss earnings quality and I believe you categorize 8 AFUDC income as paper earnings, is that correct? 9j A I may have, I don't recall having used that I 10
- term. Could you refer me to where I used that term? If you 11 ' use it I would not disagree with it.
12 ? Q It is on the 8th line. Liquidity is reduced
, 13 by AFUDC paper earnings. It is a paraphrase of that.
34l A Yes. t 15 I Q Dr. Brigham, does AFUDC income ever become l'5 i cash earnings? 17 A It should but it is still something that i 1 18 increases risk. 19 If I gave you a $20 bill versus if I gave 20 you a note saying that I was going to pay you $20, I think 21 most people would agree that the $20 you would be more sure 22 of getting $20 if I gave you a $20 bill than if I gave you 23 a note. f 24 Q Yes, Dr. Brigham, but would you agree that 25l once AFUDC income becomes cash income it does so in two waysi k uenneaca 4 masuu me. - er u. c.cr.vuow Avs. pMMSBURG. PA. m 12
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e ' Briaham-cross 1328 l 1i Basically the income that was accrued during the construction s [^ 2 , is included in the depreciation expense for the plant and is llh e 3! i charged to ratepayers as part of the depreciation expense, 4 ! and the AFUDC once capitalized and placed in service prodaces 5er a cash return to the company in the form of both return on 1 6! equity and return on debt. In other words, there is both a 7 return of and a return on AFUDC income at some point. 8 A Theoretically you are absolutely correct but 9lj theory and practice sometimes differ. 10 ! If you look at the average utility company i l 21 ; in the U.S. daring the 1970's, certainly in the last seven 12 i or eight years in the 1970's, utility commissions have told 1 13 i the companies in rate proceeding that they are allowed, in lll
,14 , quotes, to earn 12,13, L4 percent or whatever, but rarely 15 have the companies actually earned it.
I r . l 16' ; So if the companies have an authorized rate , 17 of return of, say,14 percent but they only earn, say, 18 , 12 percent, then they clearly are not earning the return on 19 that capitalized AFUDC.
~
i 20l So under perfect regulation I would agree l i 21 completely with you. Under perfect no lag regulation the l 22l quality of AFUDC earnings would be tne same as the quality i 23 of cash earnings. - 24 But in the real world that has not turned lll 25j out to be the case, and absolutely investors do not look on L 17112 uonauca . unsut. ixc. - a ne team'ww Av9 - af mmE PA.
Brigham-cross 1329 I 1i the two things as being the same. i ] 2 If you lock at any analyst report on utility l , j 3; companies you will simost invariably find percentage of l AFUDC to total earnings at the top of the quantitative 4 5 factors that they look at. 6 Q Yes, but to the extent that it is capitalized 79 and placed into service, regardless of whether it produces ! 8 any particular level of return, it does produce a cash 9 return? 10 A It is correct, some cash is better than no 11 ; cash. 12 i Q Thank you. Doctor, do you know how much of 13 f Met-Ed's and how much of Penelec's current rate base is from 14 - AFUDC income capitalized in prior years from projects which 15 have been completed to date?
- 16. A No, I don't know that.
I 17* Q I take it yotiwould not know how much of i 18i the depreciation expense currently being charged to rate-i 19 payers by those two companies or the amount that will be 20j charged to ratepayers as requested by the two companies in i 21 I this case includesa depreciation expense for capitalized i 22l AFUDC? 23l A That is correct. 24 i Q Just from your experience with utilities, 25' Dr. Brigham, would you expect that these amounts would be
McMtaACH & MARSHAL. INC. ~ 27 N LOCRWILL@W AVL " HAftRISSURG, PA. 87182
Brigham-cross 1330 1 material? ] 2l A Yes. In the case of the GPU companies with h 3' TMI-l and TMI-2 out of the rate base, they would be different 4! from most other utilities. 5j In other words, I think GPU right now would i 6f have probably less capitalized AFUDC in the current rate 1 7 case than would be true for an average company. 8 Q Conceptually is the cost of money any less of g! a real cost than the cost of any other construction item? I 10 In other words, is there any conceptual difference between gg capitalizing the cost of money and capitalizing the cost of 12 construction? 13 A Yes, I think there is. g
.14 i Q Perhaps we should have an explanation for i
15i your answer. 16 A Traditionally and historically companies 17j have not included as a cost the cost of money. That has i 18 ' traditionally been the case with industrial companies. When 19 FASB 34 came out last year industrial companies were 20l permitted to capitalize the interest component but not the i equity component of plant under construction. 21l
! Investors traditionally have looked on 22 23 i companies to finance the carrying cost of the new 24 construction projects out of existing earningr *ather than g
25l capitalizing the construction cost. I
< c iriin mounuca . musw me. - 27 m c.cxwiu.ew av.o poi ,
/
s , , Bri*than.-cros s 1331
- 1 The analogy that is given is that if the ,
2 company sells debt and sells equity to finance a project, i 3l and then in order to pay interest on the debt and the , 4! dividends on the preferred and common stcck that they sold 3l to finance the construction, they have to sell more' debt and 6l equity to pay the carrying cost of the first issues.
? The analogy has been used to the Ponzi 8 scheme where somebody would get some money under fraudulent l
9; conditions and then pay the first investors a return on I ! 10 l their money by finding some other suckers to come into it. l 11 f That is the kind of thinking that goes into it. 12 Now I think that was not a problem for the
, Q' 13 f utility industry prior to, say, 1972 or 1973 when the i
14 j companies were basically earning cost of capital and when 15l inflation had not heated up to the point where you had 16: companies that had CWIP that amounted to as much as 30 l 17! percent of the total assets. l 18 l But now ' things have built up to a point in I i 19l .he utility industry where the amount of AFUDC income as r 20! compared to cash income is so high that the companies have i 21, to raise so much new capital to pay the interest and i dividends on the old capital, and the companies have not 22l 23l been actually earning the cost of capital, the authorized i 24' rates of return, so investors would rather have cash income. { 25 I think there is a conceptual difference j unenen a unann me. - as n: cocoewww rvs ymsevne n- ama
Brigham-crona 1332 1 i 1l between cash income and AFUDC income and investors O 2l apparently share my views. O 3f Q Dr. Brigham, on Page 15 you list five items 4f which you place under government regulations which you say
)
5! impact the riskiness of utilities. Would you briefly explain i - 6 i hcw each one of those items would cause a risk to stock-7 bolders rather than to ratepayers? 8f A Well, for the same reason that I was just 9l talking about pollution abatement equipment. i 10 l Environmental Protection Agency regulations i 11 l could require a company to put scrubbers, say, on plants. 12 l Theoretically those costs should be borne by the ratepayers. O 23 !But if there is a delay in getting the rates passed through 14 ! cr comissions don't actually authorize the company and t 15 f permit it to earn sufficiently high rates to cover chose 16; costs, then the costs, or certainly some of the, are being 17' borne by stockholders. l 18! The same thing would hold with the Nuclear 19f Regulatory Ccmmission. If the Nuclear Regulatory Commission l i 20'; causes modifications to be made on an existing plant or 21i causes a redesign of plants under construction, then that is 22f going to increase the total cost of the plant when it goes 23; on line historically. ' 1 g 24l In recent years what has happened is that h)l 25 companies have not recovered the full cost of the plant and E uewRaAcw a uAnsuAL. anc. - 27 N. f.4CJCWWLGW AVC. = $ARRISS4/RC. PA. 17182 l
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l
Brinham-cross 1333 g that is easily demonstrated by looking at the amount of Q g attrition on earnings that has taken place. 3 Theoretically again customers ought to bear 4 those costs but de facto the stockholders have borne a large 5 Part of it. 6 That same situation would hold right on down 7{ the line for the other conditions. Theoretically those costs i 3l ought to be borne by ratepayers. De facto, given regulatory 9 lag and given some commission reluctance to raise rates to' 10 the extent necessary to cover those costs, stockholders are I 11 bearing part of the cost. 12 Q . Referring you to the top of Page 17 of your 13 Statement H you make a statement in the first full paragraph:
')
14 The greater risk of utilities is also illustrated by the , 15 higher yield on triple-A utility bonds than yields on 16j triple-A corporate bonds. Do you see that? i 17! A Yes. I 18; Q Do racing agencies, namely Standard & Poor's i 19 ; and Moody's use the same criteria for rating utility bonds i 20[ as they do for rating industrial bonds? i A They always look at the characteristics of 21ft 22 the company and the industry so they would be looking at 1 , l 23 ! somewhat different characteristics for utilities as for
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24 1 computer companies. 25 They look at different criteria for airlines. 1
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l l Brigham-cross 1334 l 2, Every industry would have its own factors (]) 2, that the rating agencies would consider. llk 3f Q Wouldn't diffarent coverage ratios and l 4 : capital structures, for instance, have an impact on the 5 ! analysis between utilities and industrials? 6i A Yes, and betw.?an different classes of l 7 industrials there would be differant criteria applied but 8 that does not alter the fact that after the 1960's utility 9 bond yields for any given rating category have teuded to be 10 i higher than industrial bond rating categories by more than l 11 l could be explained by differences in call provisions, f 12 ; maturities and anything else. It is a difference in risk () 13 that is apparently there. ll)
.14 , Q I would like to refer you to Page 22 of your 15 j Statement H, Dr. Brigham. Would you agree, Dr. Brigham, 16; that the only time the capital structure can be computed 17l based upon market price, as you have suggested, would be 18 l for a company which happens to have a market to book ratio of 19 f one?
i 20 A I am sorry, would you repeat that? 31l Q I said, would you agree that the only time 22 the capital structure can be computed based upon market. 2'I price, as you have suggested on Page 22, would be for a 1 company which happens to have a market to book ratio of one? gg) ss 24l 25 A No. MoHRaACH & MARSHAL. INC. - 27 N. CatXWu.t.9W AV5. - H ARRISSUTIG. PA. 17112 j
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i l Br Mham-Crooft 1335 l l 1 l Q Dr. Brigham, do you think that it might be l 1 2 fmoreappropriatetoassumethatGPUmighthaveamarket-to.- ! 3 l book ratic si:nilar to the industry average and not a market-l : i 4 to-book ratio if it were not for the TMI accident? 5 i . A Assume for what purp:se? 6 Q Let me rephrase the question. In doing your 7] analysis on page 22 of your testimony, Dr. Brigham, I guess I 8 f the question is do you think it would be more appropriate 9 instead of taking, to get a value of equity, to take a 10 j market price times the shares to take the industry average i 11 l market-to-book and assume that that would be what the GFU
- 12. stock price would proximate if the accident had not taken h 13 fplace?
l r .14 A I still don't understand when you say i 15 ; appropriate, you mean appropriate for what? For what 16' purpose? 17 If the TMI accident had not occured then 18: I think the GPU stock price should be somewhat above boom 19j value. I think that would be appropriate. 20 MR. BURGRAFF: Could we go off the record 7 21 THE ADMINISTRATIVE LAW JUDGE: Yes. 22 (An off-the-record discussion was had.) 23! BY MR. BURGRAFF: Q 24 Q There has been an off-the-record discussion. 25 between Mr. Rothschild and Dr. Brigham and Dr. Brigham has WC. - 27 fL LOCKWILLOW AYC. - dtARRISBUfN3. PA. 17112 uowRBACH Q MAgSHAt r . _ _ _
Briaham-cross 1336 1 i agreed to so mnrize the contents of that discussion. 2 l!. A Basically, what I am trying to do, on page h L 3l 22 is simply point out that GPU's book equity is 4 significantly different from the market value, 5 What Mr. Rothschild pointed out was that the 6, average utility company's book value is also below the l 7l average book equity, approximately 75 percent to 80 percent, 6 and if I were trying to make a precise refined analysis of the material contained on pages 22 and 23, I would make the 9f 10 ' kind of a judgment he is suggesting and would be comparing 11 numbers that for the average company would be in the 75 percent I 12 - to 80 parcent range for GPU would be about 25 percent. It f I 13 would be a comparison of 25 percent to 75 to 80 percent h
.14 ',
rather than 25 percent to 100 percent, and the conclusion
- {
15 l that one would reach from that would be the same as namely i l 16l I reached. Namely GPU and the GPU companies, from the standpoint of financial leverage, are still riskier in the 17 f 18' sense of the market value equity than the average company is. 19' MR. RUSSELL: The figures you are talking 20 f about are as of the time of the ' original testimony as of i July 1980, is that right? I 21f t THE WITNESS: Of course it changes as the 22{: 23I stock prices change and both the industry average atock w
, 24 price and GPU stock prices have declied since then. h 25 MR. BURGRAFF: Thank you.
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Brinham-cross 1337 1 BY MR. BURGRAFFr. 2 Q Page 23 of your statement H, Dr. Brigham, 3- you talk about dilution, is that ccrrect? Yes 4l A 5 Q And in your discussion of dilution, aren't 6 you talking about diluting the book amount of equity which l I 7 j includes a stockholder investment of TMI? I 8! A Yes, and also the stockholders' equity in { 9! other aspects , other assets. 10 , Q If it should turn out that the TMI investment i 11 ! is, in fact, worth less than its original cost either now l I l 12 or in the future, then I would assume that you would agree l t
] 13 j that the book value as currently reflected is not the -
14 book value which reflects investors' current perceptions? 15 A No. I would not necessarily agree with 16i that. I think investors look at the book value that is 17 ' published in the company's financial statements. They l 18 look at that and also look at the rate of return on it. 1 19 They look at the total dollars of earnings j that 20{ per share produced and the dividends /come out are l 31 currently zero. I think that investors look at the book l 22y value'that the accountants report and that SEC approves 23 < and if the book value is changed, the investors will look at the new book value. Q 24j 25 Q To the extent, Dr. Brigham, that the MoHRBACH ts MAR.5HAL. INC. - 27 N. EOCKWILLOW AV'E. - 34AAMfSBURG. PA, 17112
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Briaham-croan ing I I i i 1[ investors would have a current perception that TMI will O 2i indeed receive some type of write off or a totet write off : # 3[ of TMI, then the book value as currently reflected would 4 not be the book value that reflected che current perception. 5 It is a hypothetical. i 6i A If something changed would something change? 7l Q Yes. 8f , A That is pretty speculative, but if it 9 changes, it changes. I don't know that investors 10 I anticipate that there will be the kind of write off that I l 11 " you are suggesting. I think investors, based on what I l 12 l have seen of the analysts' reports, I think whae investors [ 13 S h are anticipating is a low rate of return on the existing h 14 I book value, but I haven't se.en anything that suggests that 15 investors are suggesting a write down in the book value - 16 Q Dr. Brighnm, you pointed out char the true 17 equity ratio for GPU is already below the industry average after considerations of the TMT. loss , correct? 18 f 19 ',' A Well, the market value, the market value il 20 ! equity ratio for GPU is below the industry average market i 21l valuation and the reason the market ratio value is down is i 22 f because earnings are down and expected to be down for some 23 h time because of TMI not being included in the rate base, o 1 Q 24: not earning a return on it. g 25? Q And you did. find that as the true equity I no,maAcw a MARSH A1 WC, - 17 H.1.4CKYALLOW AVT. - WARMSBURG. PA. 1*111 2
I Brigham-crocs 1339 1 ! ratio on page 22? f'y v 2 A I had put quotes around it. Probably a, 4 3
' more accure.te term that wouldn't need quotes is the market 41 value.
1 5f Q And based upon, well I guess the term true 6 equity ratio or markot value, as you describe it, you would 7 agree, would you not, that future earnings in dividends 8i r as anticipated by investors would'be much lower than if I . 9 it was not necessary to view this true equity ration or i 10 l this market value scensrio? 11 j; A If what you are saying is if TMI was I 12 to in the rate case earn a return that the market value - h 13 , would be higher, if that is the question, the answer is 14 f yes. Q Dr. Brigham, do you think there is a 15f ( 16i reasonable chance that current equity holders would view i t 17 , the issuance of new common stock as perhaps increasing 18 thepo ential earnings and dividends to GPU because such 19 l an action would decreasca potential of bankruptcy? 20 A .I don't think that the, under the current i conditions, I think there would have to be some 21l , 22 improvements in'the company's position before they could i ! 23 [ issue some stock, so I think that if the company were to Q'j 24l attempt to issue consnon stock at this point in time, I 25! think it would be looked on as a very negative sense by
! moan.4ca **nsm. me. - a te teuvnu.ow 4*. - Awuisso,ex. im2 i
Brig _.2m-cro:s 1340
- j. i i
1,! investors. I don't think investors would look on it in O 2 a positive way at all, j O r a Now if the company is able to, through this f 3{ I 4: rate case and some other rate case, if they are able to k 5 i improve the carnings, reestablish dividend payments, then i 6! the company might be able to iscue comon stock at some 7 price below the current book value, and investors might 8f be receptive to that and think it was a positive step, but i 9 not under the conditions that exist now. Not in a 10 '; non-paying dividend position right now. Not with the degree i 11 of uncertainty that exists by the company. 12 ! Q Dr. Brigham, as I 11 sten to your answer, I O- 13 ! - noe sure you addressed youreetf to whee 1 posed es a O t 14 l hypothetical. Perhaps I wil1 phrase it again. i 15; Hypothetically, if the company could issue l 16 new common stock either near or below say its current market i 17 l price, do you think there is a reasonable chance that i 18 l current equity holders would view that issuance as perhaps l 19 ; increasing the potentia 1 earnings and dividends to GPU 20! because such an action would decrease a potential of i 21l bankruptcy? t 22! (Tastimony continued on next page.) l 23 I I O *$ 9 15
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Brighm-cron s 1341 p . i l 1l A I don't think it is possible for the company j , pk4). The company can't eva issue bonds. They 2ftoissuestock. l 3! can't even raise capital by giving investor a first . priority 1 i 4! on the assets and earnings of the company. I 5: I think the premise of the question is 1 i , 0 completely invalid. The company can't sell stock. 7 THE ADMINISTRATIVE LAW JUDGE: How much more 8! do you have? I 9l MR. BURGRAFF:' Well, based on what I have 1 I 10 l done here, an hour and 15 minutes, hour and 20. l 11 il MR. RUSSELL: You say an hour and 157 ! i l 12i MR. BURGRAFF: Yes, then we will be finished. m ! (h 13 I THE ADMINISTRATIVE LAW JUDGE: How much is 14 the Staff going to have? 15l MR. PANKIW: I would say approximately a 1 i l 16i half an hour to 45 minutes altogether. i 17! MR. BURGRAFF: I might point out at this IS , point we have hardly anything for Mr. Seligson, so if you 19 would like to continue in the scirning we could do that. , 20[ THE ADMINISTRATIVE LAW JUDGE: What is the 21j de' sire of counsel? 22 MR. RUSSELL: As far as the companies are 23j concerned, we have considerable problem in not seeing the g 24f cross-examination of the witness finished up at least by the 25 Consumer Advocate's Office because the Staff has someg
" MOHRSACH & M AR$HAL.17. *. = gy N. I;eCKWILLOW AV,E. - H m 1R15 B WH G. P A. 17112 l
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s Brigham-cr:cs 1[4h ' t i 1 Mr. Spang may have some. We don't know whether any of the O 2: other parties witt have some. Mr. Wise was here ehts G 3[ morning, was not here this afternoon, but may very well be 4 I back in the morning and how much he may have I don't know. I We have Mr. Seligson coming in tomorrow 5{ i 6i morning. He should be here by 11 and we don't know how much i . I l 7; the parties will have for him. So I don't enjoy dragging things out but it 5[ i 9 i seems to me within the time frame which we are functioning i to ; we have to get on with these things. THE ADMINISTRATIVE LAW JUDGE: I would like 11 l 12 ! to get the Doctor finished off by tomorrow here, i g 13 f MR. RUSSELL: I would like to get certainly g 14 l the cross-examination of both Dr. Brigham and Mr. Seligson f 15; finished by tomort aw, and if all of this is going to be l 16: dragging off until tomorrow, I am not sure whether that is 17l going to be accomplished, to take care of both of them. i 18 i THE ADMINISTRATIVE LAW JUDGE: Let's go on i 19i for awhile. Do you want to go on for awhile? l i ! 20i MR. BURGRAFF: I have no problem. 21f THE ADMINISTRATIVE LAW JUDGE: Let's go on i 22! for a short while and see where we get. 23 I i (Discussion off the record.) 24f i THE ADMINISTRATIVE IAW JUDGE: I think g 25l: everybody would have a fresh start if we make that hour up MCHRSACH & MARSHAL. INC. - 27 N.- COCKWRLOW AV,E. - M AR H6 Et/RG PA. 17112
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1 ! tomorrow morning rstber than now.- Let's recess tmtil t ; l 2 l tomorrow morning at 9 :00. i 3 _____ 4 ; (The hearing was adjourned at 4:55 o'cicek p.m.) t. 3! ... . 6! - 7 8i 1 9.! I 10 ' 11 l . i l ^ f
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I r 13 16, 17 18 [ 19 20'. . 1 21,f l 23 f 23 ' l ueMRsACH & MARSMAL. INC. - 2F M. CSCXW1u.OW AV,E. - ;AAMWSUM& PA. I n 12 l i
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3 I hereby certify thac the proceedings and 4 evidence are contained fully and accurately in the notes ,
- 5. taken by me during the hearing of the within cause, and 6, that this is a true and correct transc.%t of the same.
7 ai ZOHRBACH & MARSHAL, INC. By Y-m f 10 i [/ JAMES P. O'HARA
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l 12 $1TIY B. MARSEAL 13 /4-//'/d h 14 13 -
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17 j (The foregoing certification of this transcript l 18.. does not apply to any reproduction of the same by any means 3 , 19:,I unless under the direct control sud/or supervision of the I i . 1 20 l certifying reporter.) i r 31' i, A$ ui '!
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