The Surface Transportation Board (STB) rejected an effort by a rail shipper organization to change the method of estimating the railroad industry’s cost of capital. The STB uses its annual estimates of the industry’s cost of capital for a variety of regulatory purposes, including rate reasonableness cases, railroad revenue adequacy determinations, feeder-line applications, rail line abandonments, trackage rights cases and rail merger reviews.
On Oct. 31, the STB denied a petition from the Western Coal Traffic League (WCTL) to abolish the use of a multistage discounted cash flow model (MSDCF) in its cost-of-capital calculations and instead rely exclusively on the capital asset pricing model (CAPM). In opposition, the Association of American Railroads argued that the STB’s current approach of using a blend of MSDCF and CAPM for cost-of-capital calculations was more reliable than any single estimate. In its decision the STB rejected the WCTL’s contention that the MSDCF overstates the cost of equity, finding that WCTL had not demonstrated that sole reliance on CAPM was superior to the use of hybrid CAPM/MSCDF methodology. The STB uses multiple models because “the MSCDF and the CAPM have different strengths and weaknesses,” and averaging them produces a more reliable estimate. As the STB observed, “while there is no single, correct way to calculate the railroad industry’s cost of equity because the true cost of equity is never revealed, using an average of the CAPM and MSDCF produces a more appropriate estimate for our regulatory purposes than reliance on CAPM alone.”
The STB’s affirmation of a multiple-model approach will have important implications for the many regulatory proceedings in which the railroad industry cost of capital is a factor.