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Federal Communications Commission
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Washington, D.C. 20554
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Internet: http://www.fcc.gov

This is an unofficial announcement of Commission action. Release of the full text of a Commission order constitutes official action. See MCI v. FCC. 515 F 2d 385 (D.C. Circ 1974).

Report No. CC 98-33 COMMON CARRIER ACTION October 5, 1998

FCC Seeks Comment on Changes to Local Telephone Companies' Rate of Return to Reflect Marketplace Conditions
(CC Docket No. 98-166)

The Commission today asked for comment on changes to the rate of return, or profit, that local telephone companies receive for providing interstate access services, such as originating and terminating long distance calls, in light of other marketplace changes. Approximately 1,300 incumbent local telephone companies are subject to "rate-of-return" regulation. This form of regulation provides incumbent local telephone companies with a reasonable profit while ensuring affordable rates for customers even before the development of meaningful competition. Since 1990, local telephone companies subject to rate-of-return regulation, which tend to be smaller, incumbent companies that serve rural and high cost areas, have been entitled to a rate of return of 11.25% for their provision of interstate access services. In today's action, the Commission noted that the cost of capital has declined, which may in turn lower local telephone companies' costs. The Commission, therefore, asked for comment on how the formula for calculating the authorized rate of return should be modified to reflect this change.

Specifically, the Commission initiated a proceeding to represcribe the authorized rate of return for interstate access services provided by local telephone companies. As a part of this proceeding, the Commission asked for comment on the methods by which it could calculate the local telephone companies' current composite weighted average cost of capital. The weighted average cost of capital is used to estimate the rate of return that the companies could earn on their investment in facilities used to provide regulated interstate services in order to attract sufficient capital investment. The composite weighted average cost of capital is the sum of the cost of debt, the cost of preferred stock, and the cost of equity, each weighted by its proportion in the companies' capital structure. The formulas for determining the cost of debt, cost of preferred stock, and capital structure are codified in Part 65 of the Commission's rules, but the rules do not include a formula for calculating the cost of equity. In today's action, the Commission proposed several methods by which the companies' cost of equity may be calculated.

In addition, the Commission asked whether this proceeding warrants a change in the low-end return level for local telephone companies that are subject to price cap regulation. Price cap companies are generally the larger local telephone companies, such as the Bell Operating Companies and GTE. These companies are subject to a limit on the prices they charge, which maintains affordable rates for customers while providing incentive for such companies to increase productivity and efficiency in order to maximize profits. At present, a price cap company with earnings of less than 10.25% (i.e. 100 basis points below the authorized rate of return) for the provision of interstate access services may request a low end adjustment, which in effect allows the company to earn no less than a 10.25% profit. In today's action, the Commission tentatively concluded that the low-end formula adjustment should remain at 100 basis points below the overall rate of return that results from this proceeding.

Action by the Commission September 8, 1998, by Notice Initiating a Prescription Proceeding and Notice of Proposed Rulemaking (FCC 98-222). Chairman Kennard, Commissioners Ness, Powell and Tristani, with Commissioner Furchtgott-Roth dissenting and issuing a separate statement.


News Media contact: Rochelle Cohen at (202) 418-0253.
Common Carrier Bureau contact: Tim Peterson at (202) 418-0844.
TTY: (202) 418-2555.

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Re: Prescribing the Authorized Rate of Return for Interstate Services for Local Exchange Carriers and Policy and Rules Concerning Rates for Dominant Carriers, CC Docket 98-166

I dissent from today's Notice of Proposed Rulemaking initiating a rate of return prescription proceeding for local exchange carriers (LECs) still subject to rate of return regulation and proposing corresponding changes to the price cap regulatory regime. On several occasions, I have expressed my continued concern with the Commission's micromanagement of LECs in general. The Commission's authority to prescribe new rates for the LECs still classified as dominant carriers and to propose changes to the low-end adjustment for price cap LECs is a mere vestige of outdated rate of return regulation. In today's increasingly competitive environment, the Commission should be focusing its efforts on transitioning to a more competitive environment for both rate of return and price cap LECs.

For example, I note that the Commission has initiated a proceeding to modify the access rules of the rate of return LECs in some minor ways to conform to the price cap rules; I supported that proceeding. In contrast, I believe that today's proceeding merely perpetuates an outmoded form of regulation. The Commission's resources would be better spent pursuing the subsequent phases alluded to in our earlier proceeding that would afford additional pricing flexibility to these carriers and propose alternative regulatory regimes that would offer additional incentives for rate of return LECs to become more efficient.

Moreover, the amount of detailed information and regulatory scrutiny required under our current price cap rules is inordinate and should be reduced. This seemingly anachronistic regulatory regime should be reformed to provide further pricing flexibility, eliminating altogether such relics as the low-end adjustment. I continue to await anxiously the opportunity to address more fully these issues and the circumstances under which dominant LECs should be accorded a simpler form of price cap regulation.

I am becoming increasingly convinced that the current regulatory mechanisms -- and certainly the level of detail -- are no longer necessary in today's increasingly competitive environment. We must develop a more forward-looking blueprint to guide the transition from regulation to competition. As I have stated previously, regulation is merely designed, to the extent possible, to replicate a competitive marketplace, but any form of regulation is an imperfect surrogate for full-fledged competition. I believe the Commission should be at least considering even further deregulation so that these cumbersome regulations are unnecessary.