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