Methodology for Determining the Railroad Industry's Cost of Capital, 55897-55900 [2019-22748]

Download as PDF Federal Register / Vol. 84, No. 202 / Friday, October 18, 2019 / Proposed Rules (iv) The sharing of the source code would create an identifiable risk to EPA mission, programs or operations. (v) The CIO believes it is in the national interest to exempt sharing the source code. (c) The Contractor shall deliver to the Contracting Officer (CO) or Contracting Officer’s Representative (COR) the underlying source code, license file, related files, build instructions, software user’s guides, automated test suites, and other associated documentation as applicable. (d) In accordance with OMB Memorandum M–16–21 the Government asserts its unlimited rights—including rights to reproduction, reuse, modification and distribution of the custom source code, associated documentation, and related files— for reuse across the federal government and as open source software for the public. These unlimited rights described above attach to all code furnished in the performance of the contract, unless the parties expressly agree otherwise in the contract. (e) The Contractor is prohibited from reselling code developed under this contract without express written consent of the EPA Contracting Officer. The Contractor must provide at least 30 days advance notice if it intends to resell code developed under this contract. (f) Technical guidance for EPA’s OSS Policy should conform with the ‘‘EPA’s Open Source Code Guidance’’ that will be maintained by the Office of Mission Support (OMS) at https://developer.epa.gov/guide/ open-source-code/ or equivalent. (g) The Contractor shall identify all deliverables and asserted restrictions as follows: (1) The Contractor shall use open source license either: (i) Identified in the contract, or (ii) Developed using one of the following licenses: (A) Creative Commons Zero (CC0); (B) MIT license; (C) GNU General Public License version 3 (GPL v3); (D) Lesser General Public License 2.1 (LGPL–2.1); (E) Apache 2.0 license; or (F) Other open source license subject to Agency approval. (2) The Contractor shall provide a copy of the proposed commercial license agreement to the Contracting Officer prior to contracting for commercial data/software. (3) The Contractor shall identify any data that will be delivered with restrictions. (4) The Contractor shall deliver the data package as specified by the EPA. (5) The Contractor shall deliver the source code to the EPA-specified version control repository and source code management system. (h) The Contractor shall comply with software and data rights requirements and provide all licenses for software dependencies as follows: (1) The Contractor shall ensure all deliverables are appropriately marked with the applicable restrictive legends. (2) The EPA is deemed to have received unlimited rights when data or software is delivered by the Contractor with restrictive markings omitted. VerDate Sep<11>2014 16:07 Oct 17, 2019 Jkt 250001 (3) If the delivery is made with restrictive markings that are not authorized by the contract, then the marking is characterized as ‘‘nonconforming.’’ In accordance with Federal Acquisition Regulation (FAR) 46.407, Nonconforming supplies or services, the Contractor will be given the chance to correct or replace the nonconforming supplies within the required delivery schedule. If the Contractor is unable to deliver conforming supplies, then the EPA is deemed to have received unlimited rights to the nonconforming supplies. (i) The Contractor shall include this clause in all subcontracts that include customdeveloped code requirements. (End of clause) [FR Doc. 2019–22435 Filed 10–17–19; 8:45 am] BILLING CODE 6560–50–P SURFACE TRANSPORTATION BOARD 49 CFR Chapter X [Docket No. EP 664 (Sub-No. 4)] Methodology for Determining the Railroad Industry’s Cost of Capital Surface Transportation Board. Notice of proposed rulemaking. AGENCY: ACTION: The Board proposes to incorporate an additional model to complement its use of the Morningstar/ Ibbotson Multi-Stage Discounted Cash Flow Model (MSDCF) and the Capital Asset Pricing Model (CAPM) in determining the cost-of-equity component of the cost of capital. DATES: Comments on the proposed rule are due by November 5, 2019. Reply comments are due by December 4, 2019. ADDRESSES: Comments and replies must be filed with the Board either via efiling or in writing addressed to: Surface Transportation Board, Attn: Docket No. EP 664 (Sub-No. 4), 395 E Street SW, Washington, DC 20423–0001. Written comments and replies will be posted to the Board’s website at www.stb.gov. FOR FURTHER INFORMATION CONTACT: Nathaniel Bawcombe at (202) 245–0376. Assistance for the hearing impaired is available through the Federal Relay Service at (800) 877–8339. SUPPLEMENTARY INFORMATION: Each year, the Board determines the railroad industry’s cost of capital and then uses this figure in a variety of regulatory proceedings, including the annual determination of railroad revenue adequacy, rate reasonableness cases, feeder line applications, rail line abandonments, trackage rights cases, and rail merger reviews. The annual cost-of-capital figure is also used as an input in the Uniform Railroad Costing SUMMARY: PO 00000 Frm 00032 Fmt 4702 Sfmt 4702 55897 System, the Board’s general purpose costing system.1 The Board calculates the cost of capital as the weighted average of the cost of debt and the cost of equity. See Methodology to be Employed in Determining the R.R. Indus.’s Cost of Capital, EP 664, slip op. at 3 (STB served Jan. 17, 2008). While the cost of debt is observable and readily available, the cost of equity (the expected return that equity investors require) can only be estimated.2 Id. Thus, ‘‘estimating the cost of equity requires relying on appropriate finance models.’’ Pet. of the W. Coal Traffic League to Inst. a Rulemaking Proceeding to Abolish the Use of the Multi-Stage Discounted Cash Flow Model in Determining the R.R. Indus.’s Cost of Equity Capital, EP 664 (Sub-No. 2), slip op. at 2 (STB served Oct. 31, 2016). In 2009, the Board moved from a costof-equity estimate based solely on CAPM to a cost-of-equity estimate based on a simple average of the estimates produced by CAPM and Morningstar/ Ibbotson MSDCF. See Use of a MultiStage Discounted Cash Flow Model in Determining the R.R. Indus.’s Cost of Capital, EP 664 (Sub-No. 1), slip op. at 15 (STB served Jan. 28, 2009). In that decision, the Board cited to the Federal Reserve Board’s testimony in Methodology to be Employed in Determining the Railroad Industry’s Cost of Capital, Docket No. EP 664, which stated that the use of multiple models ‘‘will improve estimation techniques when each model provides new information.’’ Use of a Multi-Stage Discounted Cash Flow Model, EP 664 (Sub-No. 1), slip op. at 15. Furthermore, the Board stated that ‘‘there is robust economic literature confirming that, in many cases, combining forecasts from different models is more accurate than relying on a single model.’’ 3 1 On October 11, 2019, the Board corrected the decision served on September 30, 2019. In that decision, Appendix B on page 12 incorrectly noted the 2010 cost-of-equity estimate produced by the simple average of CAPM and Morningstar/Ibbotson MSDCF as 12.98%. It has been corrected to 12.99%. Additionally, Appendix B on page 12 incorrectly noted the 2013, 2015, and 2018 cost-of-equity estimates produced by the proposed weighted average of CAPM (50%), Morningstar/Ibbotson MSDCF (25%), and Step MSDCF (25%) as 12.78%, 10.94%, and 13.46%. These values have been corrected to 12.79%, 10.95%, and 13.45%, respectively. The reference to 13.46% on page eight in the narrative portion of this decision has been likewise corrected to 13.45%. The decision remains unchanged in all other respects. 2 The Board must make ‘‘an adequate and continuing effort to assist those carriers in attaining revenue levels,’’ which should, among other objectives, ‘‘permit the raising of needed equity capital.’’ 49 U.S.C. 10704(a)(2). 3 Use of a Multi-Stage Discounted Cash Flow Model, EP 664 (Sub-No. 1), slip op. at 15 (citing E:\FR\FM\18OCP1.SGM Continued 18OCP1 55898 Federal Register / Vol. 84, No. 202 / Friday, October 18, 2019 / Proposed Rules Under CAPM, the cost of equity is equal to RF + b × RP, where RF is the risk-free rate of interest,4 RP is the market-risk premium, and b (or beta) is the measure of systematic, nondiversifiable risk. Under CAPM, the Board calculates the risk-free rate based on the average yield to maturity for a 20year U.S. Treasury Bond. The estimate for the market-risk premium is based on returns experienced by the S&P 500 since 1926. Lastly, beta is calculated by using a portfolio of weekly, mergeradjusted railroad stock returns for the prior five years. Under Morningstar/Ibbotson MSDCF, the cost of equity is the discount rate that equates a firm’s market value to the present value of the expected stream of cash flows. Morningstar/Ibbotson MSDCF calculates growth of earnings in three stages. In the first stage (years one through five), the qualifying railroad’s 5 annual earnings growth rate is assumed to be the median value of its three- to five-year growth rate estimates, as determined by railroad industry analysts and published by the Institutional Brokers Estimate System.6 In the second stage (years six through 10), the growth rate is the simple average of all of the qualifying railroads’ median three- to five-year growth rate estimates in stage one. In the third stage (years 11 and onwards), the growth rate is the long-run nominal growth rate of the U.S. economy. This long-run nominal growth rate is estimated by using the historical growth in real Gross Domestic Product plus the long-run expected inflation rate. Proposed Rule The Board proposes to add an additional model, which the Board will refer to as ‘‘Step MSDCF’’ to the cost-ofDavid F. Hendry & Michael P. Clements, Pooling of Forecasts, VII Econometrics Journal 1 (2004); J.M. Bates & C.W.J. Granger, The Combination of Forecasts in Essays in Econometrics: Collected Papers of Clive W.J. Granger, Vol. I: Spectral Analysis, Seasonality, Nonlinearity, Methodology, & Forecasting 391–410 (Eric Ghysels, Norman R. Swanson, & Mark W. Watson, eds., 2001); Spyros Makridakis & Robert L. Winkler, Averages of Forecasts: Some Empirical Results, XXIX Management Science 987 (1983)). 4 The risk-free rate of interest is an exogenously determined interest rate at which investors may borrow or lend without fear of default. 5 The Board determines the railroad industry’s cost of capital for a ‘‘composite railroad,’’ which is based on data from Class I carriers that meet certain criteria developed in Railroad Cost of Capital— 1984, 1 I.C.C.2d 989 (1985), as modified by Revisions to the Cost-of-Capital Composite Railroad Criteria, EP 664 (Sub-No. 3) (STB served Oct. 25, 2017). 6 This data can be retrieved from Refinitiv (formerly Thomson ONE Investment Management). See Railroad Cost of Capital—2018, EP 558 (SubNo. 22), slip op. at 9 (STB served Aug. 6, 2019) VerDate Sep<11>2014 16:07 Oct 17, 2019 Jkt 250001 capital calculation, as described below.7 Consistent with the Board’s present methodology, in which CAPM and MSDCF approaches each comprise 50% of the cost-of-equity estimate, the Board proposes to calculate the cost of capital by using the weighted average of the three models, with CAPM weighted at 50%, Morningstar/Ibbotson MSDCF weighted at 25%, and Step MSDCF weighted at 25%. As the Board has stated previously, there is no single simple or correct way to estimate the cost of equity for the railroad industry, and many model options are available. Use of a MultiStage Discounted Cash Flow Model, EP 664 (Sub-No. 1), slip op. at 15; see also Pet. of the W. Coal Traffic League, EP 664 (Sub-No. 2), slip op. at 2, 20 (STB served Oct. 31, 2016). The Board has acknowledged that ‘‘by using multiple models that are based on different perspectives and rely on different inputs, the Board benefits because anomalies affecting one model are less likely to affect the other.’’ Pet. of the W. Coal Traffic League, EP 664 (Sub-No. 2), slip op. at 3 (STB served Apr. 28, 2017). The Board has previously determined that a methodology that uses multiple models is more robust than a methodology that utilizes only one model, not because one model is ‘‘conceptually or pragmatically superior to the other,’’ but rather because each has different strengths and weaknesses. Pet. of the W. Coal Traffic League, EP 664 (Sub-No. 2), slip op. at 11 (STB served Oct. 31, 2016). Accordingly, the Board finds that its cost-of-capital determinations could be strengthened by the addition of a new model to improve the robustness of its calculations. Since 2009, the Board has found that the simple average of CAPM and Morningstar/Ibbotson MSDCF has produced a reasonable estimate of the cost of equity used to gauge the financial health of the railroad industry. Most recently, in Railroad Cost of Capital—2018, EP 558 (Sub-No. 22), slip op. at 2–3 (STB served Aug. 6, 2019), discussed in more detail below, the Board once again affirmed this established methodology as reasonable. However, in that decision, the Board also noted that, when appropriate, the Board has undertaken an examination of whether changes to its cost-of-capital methodology may be warranted, and stated that it expected to open a proceeding to further explore whether 7 Step MSDCF is similar to the model presented in Aswath Damodaran, Investment Valuation: Tools & Techniques for Determining the Value of Any Asset 317 (3d ed. 2012). PO 00000 Frm 00033 Fmt 4702 Sfmt 4702 modifications to its cost-of-capital methodology may be appropriate. Id. at 3. In the proceeding to update the railroad industry’s cost of capital for 2018, the Board received comments from the Association of American Railroads (AAR) providing the information used to make the annual cost-of-capital determination. See generally AAR Comments, Apr. 22, 2019, R.R. Cost of Capital—2018, EP 558 (Sub-No. 22). The supporting data submitted with AAR’s filing reflected a significant increase in growth rates 8 and the cost of capital. Specifically, the 2018 cost of capital (12.22%) is 2.18 percentage points higher than the 2017 cost of capital (10.04%). According to AAR, lower tax rates and rail operating changes, among other factors, contributed to analysts’ higher growth expectations.9 At present, three of the four qualifying railroads included in the Board’s cost-of-capital calculations have implemented some form of operating changes, which are generally referred to as ‘‘precision scheduled railroading.’’ 10 Significant operating changes that occur over a relatively short period of time can have a unique effect on the Board’s annual cost-of-capital determination, particularly if they are neither one-time events 11 nor expected 8 The second stage growth rate estimate produced by Morningstar/Ibbotson MSDCF (i.e., the average of the qualifying railroads’ individual three- to fiveyear median growth rates) produced a value of 19.88%, which is significantly higher than the second stage growth rate value of 13.55% reflected in the 2017 cost-of-capital decision. See R.R. Cost of Capital—2018, EP 558 (Sub-No. 22), slip op. at 17; R.R. Cost of Capital—2017, EP 558 (Sub-No. 21), slip op. at 18 (STB served Dec. 6, 2018). Likewise, CSX Corporation’s first stage growth rate rose significantly from 15.66% in 2017 to 27.43% in 2018. See R.R. Cost of Capital—2018, EP 558 (SubNo. 22), slip op. at 17; R.R. Cost of Capital—2017, EP 558 (Sub-No. 21), slip op. at 18. 9 See AAR Comments, V.S. John Gray 45–46, Apr. 22, 2019, R.R. Cost of Capital—2018, EP 558 (SubNo. 22) (‘‘Based on train-miles reported in Annual Report Form R–1, 2015 and 2016 were recession years for the railroad industry, and train-miles have not yet recovered to 2014 levels—even if unit trains (mostly coal) are excluded. Thus, it is not surprising that analysts now have higher growth expectations, especially when considering other factors such as lower tax rates and the implementation of precision scheduled railroading.’’). 10 See Letter from E. Hunter Harrison, thenChairman & Chief Exec. Officer, CSX Corp., in response to August 14, 2017 letter from Board Members, at 1, www.stb.gov (open ‘‘Rail Service Data’’ under ‘‘Quick Links’’ and select ‘‘CSX Response, Service Outlook and Milestones, August 24, 2017’’ hyperlink); see also, U.S. Dept. of Agric. Grain Transp. Report 2 (Dec. 20, 2018), http:// dx.doi.org/10.9752/TS056.12-20-018. 11 For example, significant operating changes like precision scheduled railroading are not like the enactment of the Tax Cuts and Jobs Act, Public Law 115–97, 131 Stat. 2054 (2017), which was a onetime occurrence that merited a one-time adjustment to the cost of capital. See R.R. Revenue Adequacy— E:\FR\FM\18OCP1.SGM 18OCP1 Federal Register / Vol. 84, No. 202 / Friday, October 18, 2019 / Proposed Rules to cause permanent changes in the industry’s growth rates. Once significant operating changes are fully implemented, any rate of growth that accompanied the operating changes may not continue to increase at the same level. Because the operating changes will, and future railroad changes that are currently unknown could, have a significant impact on the Board’s costof-capital determination, the Board finds that now is an appropriate time to consider the addition of a model that could improve its methodology for estimating the cost-of-equity component of the cost of capital. As described in more detail below, the Board finds that the addition of Step MSDCF, when used in combination with the current Morningstar/Ibbotson MSDCF and CAPM, could enhance the robustness of the resulting cost-of-equity estimate during periods, like the present one, in which certain railroads are undertaking significant operating changes. Furthermore, consistent with the Board’s previous finding, supported by extensive economic literature, that averaging multiple models—based on different perspectives, relying on different inputs, and with different strengths and weaknesses—would produce estimates that are more robust when averaged together,12 the addition of Step MSDCF would improve the costof-capital determination, including during periods of significant operating changes. Like Morningstar/Ibbotson MSDCF, Step MSDCF proposed here would continue to calculate growth of earnings in three stages. The first and third stages would be identical to those of Morningstar/Ibbotson MSDCF. In the first stage (years one through five), the qualifying railroad’s annual earnings growth rate would be the median value of its three- to five-year growth rate estimates and, in the third stage (years 11 and onwards), the growth rate would be the long-run nominal growth rate of the U.S. economy. The growth rate of the second stage (years six through 10) would be a gradual transition between the first and third stages. The transition would begin at year six and step down or up in equal increments each year towards the terminal growth rate (or third stage). The algebraic formula for Step MSDCF is described in full in Appendix A. The Board proposes to add Step MSDCF to its cost-of-capital 2017 Determination, EP 552 (Sub-No. 22) et al., slip op. at 1–3 (STB served Dec. 6, 2018). 12 See Pet. of the W. Coal Traffic League, EP 664 (Sub-No. 2), slip op. at 11 (STB served Oct. 31, 2016). VerDate Sep<11>2014 16:07 Oct 17, 2019 Jkt 250001 methodology based in part on input from commenters in prior proceedings. Since the Board’s adoption of its current hybrid methodology in 2009, Western Coal Traffic League (WCTL) has opposed the Board’s use of Morningstar/ Ibbotson MSDCF in its cost-of-equity calculation. One of WCTL’s primary criticisms has been that using the average of all of the qualifying railroads’ median growth rates in stage one as the growth rate in stage two is unreasonable because three- to five-year forecasts of earnings growth will not likely be accurate for ten years. See Use of a Multi-Stage Discounted Cash Flow Model, EP 664 (Sub-No. 1), slip op. at 8–9. Additionally, WCTL has argued that Morningstar/Ibbotson MSDCF lacks a transition mechanism, which prevents smooth transitions between stages. See Pet. of the W. Coal Traffic League, EP 664 (Sub-No. 2), slip op. at 9 (STB served Oct. 31, 2016). In affirming the reasonableness of Morningstar/Ibbotson MSDCF’s secondstage growth rate, the Board has noted that (1) the returns of individual firms should revert to the industry average over time, (2) it is not realistic to predict growth for individual companies beyond five years, and (3) attempting to create smoother transitions between the stages would add more complexity to the model but would not guarantee more precision, in part, because the cost of equity cannot ever be truly known. See Pet. of the W. Coal Traffic League, EP 664 (Sub-No. 2), slip op. at 13 (STB served Oct. 31, 2016). The Board continues to believe that Morningstar/ Ibbotson MSDCF is reasonable. At the same time, there are other reasonable models based on different perspectives, relying on different inputs, and with different strengths and weaknesses. Forecasting growth rates in years six through 10 is inherently imprecise, and it is not possible to predict whether one model will better reflect future events, particularly when those events must be judged over decades of differing market characteristics. The Board’s proposal to incorporate another model to improve the robustness of its overall cost-ofequity estimate implies neither that the Board expects to achieve perfect precision across models nor that the Board’s existing models are inadequate. The Board finds it is reasonable to continue to rely on Morningstar/ Ibbotson MSDCF as one aspect of its cost-of-capital methodology. Even so, the Board recognizes that the significant operating changes undertaken by certain individual railroads have given those railroads a significant increase in growth rates that flows through to the second stage of PO 00000 Frm 00034 Fmt 4702 Sfmt 4702 55899 Morningstar/Ibbotson MSDCF, and it is always possible that future railroad changes could have a similar effect. Specifically, because the second-stage growth rate in Morningstar/Ibbotson MSDCF uses the simple average of all qualifying railroads’ three- to five-year median growth rate estimates from the first stage, the growth rates in the middle horizon (years six through 10) will be similar to the averages of growth rates in the short term (three- to fiveyear estimates). By drawing upon the three- to five-year growth rate estimates twice, Morningstar/Ibbotson MSDCF is more sensitive to growth rate changes in the short term, which may involve anomalous increases or decreases, relative to a model with a gradual transition between the first and third stages. While reasonable, Morningstar/ Ibbotson MSDCF may not capture information relevant to the middle horizon in the same way as other models.13 Therefore, the Board’s cost-ofequity estimate could yet be made more robust by adding a model, like Step MSDCF, that reflects a different perspective for the middle horizon.14 The Board proposes to retain the same CAPM that it has used to calculate the cost of capital since 2008. See Methodology to be Employed in Determining the R.R. Indus.’s Cost of Capital, EP 664, slip op. at 2. The Board’s current methods for determining the railroad industry’s beta and estimating market-risk premium are reasonable. Furthermore, recent 13 The Board has repeatedly rejected WCTL’s argument that Morningstar/Ibbotson MSDCF should be abandoned due to what WCTL argues is its flawed second-stage growth rate, but the Board has not previously considered how a MSDCF variation with a different second-stage growth rate could supplement Morningstar/Ibbotson MSDCF. The Board proposes that Step MSDCF could be useful as a supplement, rather than a replacement, for Morningstar/Ibbotson MSDCF because, while Step MSDCF adds a different perspective with respect to growth rates, Step MSDCF may not necessarily be more reasonable than Morningstar/Ibbotson MSDCF in certain periods or over the long term. 14 In comments submitted for the 2018 cost-ofcapital proceeding, AAR stated that Morningstar/ Ibbotson MSDCF ‘‘assumes ‘that over a middle horizon, growth of any particular company will lie more in line with the industry as a whole,’’ which means that ‘‘other companies ‘catch’ their industry growth leaders, or the leaders fall back to the rate of the slower growth railroads.’’ Accordingly, AAR argued that ‘‘[a]ny attempt to change the second stage to a transition stage is corrupting the intent of the model.’’ AAR Comments, V.S. John Gray 45, Apr. 22, 2019, R.R. Cost of Capital—2018, EP 558 (Sub-No. 22). The Board does not propose to modify Morningstar/Ibbotson MSDCF in this decision. Instead, the Board proposes to add a new model that relies on different assumptions to be used alongside Morningstar/Ibbotson MSDCF. This approach allows the Board to introduce a model that will have a moderating influence on Morningstar/Ibbotson MSDCF while also maintaining the integrity of Morningstar/Ibbotson MSDCF. E:\FR\FM\18OCP1.SGM 18OCP1 55900 Federal Register / Vol. 84, No. 202 / Friday, October 18, 2019 / Proposed Rules operating changes have not demonstrated similar issues in the costof-equity estimates produced by CAPM as they have for Morningstar/Ibbotson MSDCF. Accordingly, the Board proposes that to reduce the impact of short-term operating changes on the cost of capital, it is not necessary for the Board to modify CAPM. CAPM, generally, is a backwardlooking model while MSDCF is more forward-looking, each looking at different market data. R.R. Cost of Capital—2018, EP 558 (Sub-No. 22), slip op. at 3. To maintain an equal balance between forward-looking and backwardlooking models, the Board proposes to use a weighted average of the three models in its cost-of-equity calculation, with CAPM weighted at 50%, Morningstar/Ibbotson MSDCF weighted at 25%, and Step MSDCF weighted at 25%. Furthermore, because the Board has not found that MSDCF is superior to CAPM, or vice versa, it is reasonable to use a weighted average of the three models that allows both model types to continue to contribute equally to the cost of equity. When applied over a 10-year historical analysis period, the weighted average of the three models results in a lower variance than a forecast relying on the average of CAPM and Morningstar/ Ibbotson MSDCF alone. For the period 2009 through 2018, the average of CAPM and Morningstar/Ibbotson MSDCF produces a cost of equity ranging from 10.31% to 13.86% with a standard deviation of 1.18. Over the same period, the weighted average of the three models produces estimates between 10.25% and 13.45% with a standard deviation of 1.09. See Appendix B. Adding Step MSDCF to the Board’s current methodology for calculating the cost of capital is consistent with the Rail Transportation Policy. 49 U.S.C. 10101. For instance, having a methodology that more robustly estimates the cost-ofequity component of the cost of capital would better ensure that rail carriers are allowed to earn adequate revenues. section 10101(3); see also Standards for R.R. Revenue Adequacy, 364 I.C.C. 803, 811 (1981), aff’d sub nom. Bessemer & Lake Erie R.R. v. ICC, 691 F.2d 1104 (3d Cir. 1982) (concluding that ‘‘the only revenue adequacy standard consistent with the requirements of [The Staggers Rail Act of 1980] is one that uses a rate of return equal to the cost of capital’’). As noted, Morningstar/Ibbotson MSDCF is more sensitive to growth rate changes in the short term relative to Step MSDCF, and Step MSDCF may be better suited for some periods, or even over the long run. VerDate Sep<11>2014 16:07 Oct 17, 2019 Jkt 250001 Interested parties are invited to comment on the proposed use of Step MSDCF described above in conjunction with CAPM and Morningstar/Ibbotson MSDCF currently used by the Board. Parties are encouraged to address issues such as the most appropriate way to integrate the three models into the costof-capital calculation, including the particular weighting that each model should have. Regulatory Flexibility Act The Regulatory Flexibility Act of 1980 (RFA), 5 U.S.C. 601–612, generally requires a description and analysis of new rules that would have a significant economic impact on a substantial number of small entities. In drafting a rule, an agency is required to: (1) Assess the effect that its regulation will have on small entities, (2) analyze effective alternatives that may minimize a regulation’s impact, and (3) make the analysis available for public comment. Section 601–604. In its notice of proposed rulemaking, the agency must either include an initial regulatory flexibility analysis, section 603(a), or certify that the proposed rule would not have a ‘‘significant impact on a substantial number of small entities,’’ section 605(b). Because the goal of the RFA is to reduce the cost to small entities of complying with federal regulations, the RFA requires an agency to perform a regulatory flexibility analysis of small entity impacts only when a rule directly regulates those entities. In other words, the impact must be a direct impact on small entities ‘‘whose conduct is circumscribed or mandated’’ by the proposed rule. White Eagle Coop. v. Conner, 553 F.3d 467, 480 (7th Cir. 2009). The Board certifies under 5 U.S.C. 605(b) that this rule would not have a significant economic impact on a substantial number of small entities as defined by the RFA. Cost of capital is calculated for those Class I carriers that meet certain criteria developed in Railroad Cost of Capital—1984, 1 I.C.C.2d 989 (1985), and modified in Revisions to the Cost-of-Capital Composite Railroad Criteria, EP 664 (Sub-No. 3) (STB served Oct. 25, 2017). Therefore, the Board’s proposed methodology will apply only to Class I rail carriers, and there will be no impact on small railroads. A copy of this decision will be served upon the Chief Counsel for Advocacy, Office of Advocacy, U.S. Small Business Administration, Washington, DC 20416. Additional information supporting the Board’s revised proposal is contained in the Board’s decision (including appendices) served on PO 00000 Frm 00035 Fmt 4702 Sfmt 4702 October 11, 2019. To obtain a copy of this decision, visit the Board’s website at http://www.stb.gov. It is ordered: 1. The Board proposes to revise its methodology for determining the railroad industry’s cost of capital as set forth in this decision. Notice of this decision will be published in the Federal Register. 2. Comments are due by November 5, 2019. Reply comments are due by December 4, 2019. 3. A copy of this decision will be served upon the Chief Counsel for Advocacy, Office of Advocacy, U.S. Small Business Administration. 4. This decision is effective on its service date. Decided: October 11, 2019. By the Board, Board Member Begeman, Fuchs, and Oberman. Kenyatta Clay, Clearance Clerk. [FR Doc. 2019–22748 Filed 10–17–19; 8:45 am] BILLING CODE 4915–01–P DEPARTMENT OF COMMERCE National Oceanic and Atmospheric Administration 50 CFR Part 622 [Docket No. 191011–0061] RIN 0648–BJ01 Fisheries of the Caribbean, Gulf of Mexico, and South Atlantic; Spiny Lobster Trap Fishery of the U.S. Virgin Islands (USVI); Control Date National Marine Fisheries Service (NMFS), National Oceanic and Atmospheric Administration (NOAA), Commerce. ACTION: Advance notice of proposed rulemaking; consideration of a control date. AGENCY: This notice announces the establishment of a control date of September 1, 2017, that the Caribbean Fishery Management Council (Council) may use if it decides to create restrictions limiting participation in the spiny lobster trap fishery in the exclusive economic zone (EEZ) off St. Thomas and St. John, or St. Croix, U.S. Virgin Islands (USVI). Persons entering the fishery in either area after the control date will not be assured of future access should a management regime that limits participation in the fishery be prepared and implemented. NMFS invites comments on the establishment of this control date. SUMMARY: E:\FR\FM\18OCP1.SGM 18OCP1

Agencies

[Federal Register Volume 84, Number 202 (Friday, October 18, 2019)]
[Proposed Rules]
[Pages 55897-55900]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-22748]


=======================================================================
-----------------------------------------------------------------------

SURFACE TRANSPORTATION BOARD

49 CFR Chapter X

[Docket No. EP 664 (Sub-No. 4)]


Methodology for Determining the Railroad Industry's Cost of 
Capital

AGENCY: Surface Transportation Board.

ACTION: Notice of proposed rulemaking.

-----------------------------------------------------------------------

SUMMARY: The Board proposes to incorporate an additional model to 
complement its use of the Morningstar/Ibbotson Multi-Stage Discounted 
Cash Flow Model (MSDCF) and the Capital Asset Pricing Model (CAPM) in 
determining the cost-of-equity component of the cost of capital.

DATES: Comments on the proposed rule are due by November 5, 2019. Reply 
comments are due by December 4, 2019.

ADDRESSES: Comments and replies must be filed with the Board either via 
e-filing or in writing addressed to: Surface Transportation Board, 
Attn: Docket No. EP 664 (Sub-No. 4), 395 E Street SW, Washington, DC 
20423-0001. Written comments and replies will be posted to the Board's 
website at www.stb.gov.

FOR FURTHER INFORMATION CONTACT: Nathaniel Bawcombe at (202) 245-0376. 
Assistance for the hearing impaired is available through the Federal 
Relay Service at (800) 877-8339.

SUPPLEMENTARY INFORMATION: Each year, the Board determines the railroad 
industry's cost of capital and then uses this figure in a variety of 
regulatory proceedings, including the annual determination of railroad 
revenue adequacy, rate reasonableness cases, feeder line applications, 
rail line abandonments, trackage rights cases, and rail merger reviews. 
The annual cost-of-capital figure is also used as an input in the 
Uniform Railroad Costing System, the Board's general purpose costing 
system.\1\
---------------------------------------------------------------------------

    \1\ On October 11, 2019, the Board corrected the decision served 
on September 30, 2019. In that decision, Appendix B on page 12 
incorrectly noted the 2010 cost-of-equity estimate produced by the 
simple average of CAPM and Morningstar/Ibbotson MSDCF as 12.98%. It 
has been corrected to 12.99%. Additionally, Appendix B on page 12 
incorrectly noted the 2013, 2015, and 2018 cost-of-equity estimates 
produced by the proposed weighted average of CAPM (50%), 
Morningstar/Ibbotson MSDCF (25%), and Step MSDCF (25%) as 12.78%, 
10.94%, and 13.46%. These values have been corrected to 12.79%, 
10.95%, and 13.45%, respectively. The reference to 13.46% on page 
eight in the narrative portion of this decision has been likewise 
corrected to 13.45%. The decision remains unchanged in all other 
respects.
---------------------------------------------------------------------------

    The Board calculates the cost of capital as the weighted average of 
the cost of debt and the cost of equity. See Methodology to be Employed 
in Determining the R.R. Indus.'s Cost of Capital, EP 664, slip op. at 3 
(STB served Jan. 17, 2008). While the cost of debt is observable and 
readily available, the cost of equity (the expected return that equity 
investors require) can only be estimated.\2\ Id. Thus, ``estimating the 
cost of equity requires relying on appropriate finance models.'' Pet. 
of the W. Coal Traffic League to Inst. a Rulemaking Proceeding to 
Abolish the Use of the Multi-Stage Discounted Cash Flow Model in 
Determining the R.R. Indus.'s Cost of Equity Capital, EP 664 (Sub-No. 
2), slip op. at 2 (STB served Oct. 31, 2016).
---------------------------------------------------------------------------

    \2\ The Board must make ``an adequate and continuing effort to 
assist those carriers in attaining revenue levels,'' which should, 
among other objectives, ``permit the raising of needed equity 
capital.'' 49 U.S.C. 10704(a)(2).
---------------------------------------------------------------------------

    In 2009, the Board moved from a cost-of-equity estimate based 
solely on CAPM to a cost-of-equity estimate based on a simple average 
of the estimates produced by CAPM and Morningstar/Ibbotson MSDCF. See 
Use of a Multi-Stage Discounted Cash Flow Model in Determining the R.R. 
Indus.'s Cost of Capital, EP 664 (Sub-No. 1), slip op. at 15 (STB 
served Jan. 28, 2009). In that decision, the Board cited to the Federal 
Reserve Board's testimony in Methodology to be Employed in Determining 
the Railroad Industry's Cost of Capital, Docket No. EP 664, which 
stated that the use of multiple models ``will improve estimation 
techniques when each model provides new information.'' Use of a Multi-
Stage Discounted Cash Flow Model, EP 664 (Sub-No. 1), slip op. at 15. 
Furthermore, the Board stated that ``there is robust economic 
literature confirming that, in many cases, combining forecasts from 
different models is more accurate than relying on a single model.'' \3\
---------------------------------------------------------------------------

    \3\ Use of a Multi-Stage Discounted Cash Flow Model, EP 664 
(Sub-No. 1), slip op. at 15 (citing David F. Hendry & Michael P. 
Clements, Pooling of Forecasts, VII Econometrics Journal 1 (2004); 
J.M. Bates & C.W.J. Granger, The Combination of Forecasts in Essays 
in Econometrics: Collected Papers of Clive W.J. Granger, Vol. I: 
Spectral Analysis, Seasonality, Nonlinearity, Methodology, & 
Forecasting 391-410 (Eric Ghysels, Norman R. Swanson, & Mark W. 
Watson, eds., 2001); Spyros Makridakis & Robert L. Winkler, Averages 
of Forecasts: Some Empirical Results, XXIX Management Science 987 
(1983)).

---------------------------------------------------------------------------

[[Page 55898]]

    Under CAPM, the cost of equity is equal to RF + [beta] x RP, where 
RF is the risk-free rate of interest,\4\ RP is the market-risk premium, 
and [beta] (or beta) is the measure of systematic, non-diversifiable 
risk. Under CAPM, the Board calculates the risk-free rate based on the 
average yield to maturity for a 20-year U.S. Treasury Bond. The 
estimate for the market-risk premium is based on returns experienced by 
the S&P 500 since 1926. Lastly, beta is calculated by using a portfolio 
of weekly, merger-adjusted railroad stock returns for the prior five 
years.
---------------------------------------------------------------------------

    \4\ The risk-free rate of interest is an exogenously determined 
interest rate at which investors may borrow or lend without fear of 
default.
---------------------------------------------------------------------------

    Under Morningstar/Ibbotson MSDCF, the cost of equity is the 
discount rate that equates a firm's market value to the present value 
of the expected stream of cash flows. Morningstar/Ibbotson MSDCF 
calculates growth of earnings in three stages. In the first stage 
(years one through five), the qualifying railroad's \5\ annual earnings 
growth rate is assumed to be the median value of its three- to five-
year growth rate estimates, as determined by railroad industry analysts 
and published by the Institutional Brokers Estimate System.\6\ In the 
second stage (years six through 10), the growth rate is the simple 
average of all of the qualifying railroads' median three- to five-year 
growth rate estimates in stage one. In the third stage (years 11 and 
onwards), the growth rate is the long-run nominal growth rate of the 
U.S. economy. This long-run nominal growth rate is estimated by using 
the historical growth in real Gross Domestic Product plus the long-run 
expected inflation rate.
---------------------------------------------------------------------------

    \5\ The Board determines the railroad industry's cost of capital 
for a ``composite railroad,'' which is based on data from Class I 
carriers that meet certain criteria developed in Railroad Cost of 
Capital--1984, 1 I.C.C.2d 989 (1985), as modified by Revisions to 
the Cost-of-Capital Composite Railroad Criteria, EP 664 (Sub-No. 3) 
(STB served Oct. 25, 2017).
    \6\ This data can be retrieved from Refinitiv (formerly Thomson 
ONE Investment Management). See Railroad Cost of Capital--2018, EP 
558 (Sub-No. 22), slip op. at 9 (STB served Aug. 6, 2019)
---------------------------------------------------------------------------

Proposed Rule

    The Board proposes to add an additional model, which the Board will 
refer to as ``Step MSDCF'' to the cost-of-capital calculation, as 
described below.\7\ Consistent with the Board's present methodology, in 
which CAPM and MSDCF approaches each comprise 50% of the cost-of-equity 
estimate, the Board proposes to calculate the cost of capital by using 
the weighted average of the three models, with CAPM weighted at 50%, 
Morningstar/Ibbotson MSDCF weighted at 25%, and Step MSDCF weighted at 
25%.
---------------------------------------------------------------------------

    \7\ Step MSDCF is similar to the model presented in Aswath 
Damodaran, Investment Valuation: Tools & Techniques for Determining 
the Value of Any Asset 317 (3d ed. 2012).
---------------------------------------------------------------------------

    As the Board has stated previously, there is no single simple or 
correct way to estimate the cost of equity for the railroad industry, 
and many model options are available. Use of a Multi-Stage Discounted 
Cash Flow Model, EP 664 (Sub-No. 1), slip op. at 15; see also Pet. of 
the W. Coal Traffic League, EP 664 (Sub-No. 2), slip op. at 2, 20 (STB 
served Oct. 31, 2016). The Board has acknowledged that ``by using 
multiple models that are based on different perspectives and rely on 
different inputs, the Board benefits because anomalies affecting one 
model are less likely to affect the other.'' Pet. of the W. Coal 
Traffic League, EP 664 (Sub-No. 2), slip op. at 3 (STB served Apr. 28, 
2017). The Board has previously determined that a methodology that uses 
multiple models is more robust than a methodology that utilizes only 
one model, not because one model is ``conceptually or pragmatically 
superior to the other,'' but rather because each has different 
strengths and weaknesses. Pet. of the W. Coal Traffic League, EP 664 
(Sub-No. 2), slip op. at 11 (STB served Oct. 31, 2016). Accordingly, 
the Board finds that its cost-of-capital determinations could be 
strengthened by the addition of a new model to improve the robustness 
of its calculations.
    Since 2009, the Board has found that the simple average of CAPM and 
Morningstar/Ibbotson MSDCF has produced a reasonable estimate of the 
cost of equity used to gauge the financial health of the railroad 
industry. Most recently, in Railroad Cost of Capital--2018, EP 558 
(Sub-No. 22), slip op. at 2-3 (STB served Aug. 6, 2019), discussed in 
more detail below, the Board once again affirmed this established 
methodology as reasonable. However, in that decision, the Board also 
noted that, when appropriate, the Board has undertaken an examination 
of whether changes to its cost-of-capital methodology may be warranted, 
and stated that it expected to open a proceeding to further explore 
whether modifications to its cost-of-capital methodology may be 
appropriate. Id. at 3.
    In the proceeding to update the railroad industry's cost of capital 
for 2018, the Board received comments from the Association of American 
Railroads (AAR) providing the information used to make the annual cost-
of-capital determination. See generally AAR Comments, Apr. 22, 2019, 
R.R. Cost of Capital--2018, EP 558 (Sub-No. 22). The supporting data 
submitted with AAR's filing reflected a significant increase in growth 
rates \8\ and the cost of capital. Specifically, the 2018 cost of 
capital (12.22%) is 2.18 percentage points higher than the 2017 cost of 
capital (10.04%). According to AAR, lower tax rates and rail operating 
changes, among other factors, contributed to analysts' higher growth 
expectations.\9\ At present, three of the four qualifying railroads 
included in the Board's cost-of-capital calculations have implemented 
some form of operating changes, which are generally referred to as 
``precision scheduled railroading.'' \10\
---------------------------------------------------------------------------

    \8\ The second stage growth rate estimate produced by 
Morningstar/Ibbotson MSDCF (i.e., the average of the qualifying 
railroads' individual three- to five-year median growth rates) 
produced a value of 19.88%, which is significantly higher than the 
second stage growth rate value of 13.55% reflected in the 2017 cost-
of-capital decision. See R.R. Cost of Capital--2018, EP 558 (Sub-No. 
22), slip op. at 17; R.R. Cost of Capital--2017, EP 558 (Sub-No. 
21), slip op. at 18 (STB served Dec. 6, 2018). Likewise, CSX 
Corporation's first stage growth rate rose significantly from 15.66% 
in 2017 to 27.43% in 2018. See R.R. Cost of Capital--2018, EP 558 
(Sub-No. 22), slip op. at 17; R.R. Cost of Capital--2017, EP 558 
(Sub-No. 21), slip op. at 18.
    \9\ See AAR Comments, V.S. John Gray 45-46, Apr. 22, 2019, R.R. 
Cost of Capital--2018, EP 558 (Sub-No. 22) (``Based on train-miles 
reported in Annual Report Form R-1, 2015 and 2016 were recession 
years for the railroad industry, and train-miles have not yet 
recovered to 2014 levels--even if unit trains (mostly coal) are 
excluded. Thus, it is not surprising that analysts now have higher 
growth expectations, especially when considering other factors such 
as lower tax rates and the implementation of precision scheduled 
railroading.'').
    \10\ See Letter from E. Hunter Harrison, then-Chairman & Chief 
Exec. Officer, CSX Corp., in response to August 14, 2017 letter from 
Board Members, at 1, www.stb.gov (open ``Rail Service Data'' under 
``Quick Links'' and select ``CSX Response, Service Outlook and 
Milestones, August 24, 2017'' hyperlink); see also, U.S. Dept. of 
Agric. Grain Transp. Report 2 (Dec. 20, 2018), http://dx.doi.org/10.9752/TS056.12-20-018.
---------------------------------------------------------------------------

    Significant operating changes that occur over a relatively short 
period of time can have a unique effect on the Board's annual cost-of-
capital determination, particularly if they are neither one-time events 
\11\ nor expected

[[Page 55899]]

to cause permanent changes in the industry's growth rates. Once 
significant operating changes are fully implemented, any rate of growth 
that accompanied the operating changes may not continue to increase at 
the same level. Because the operating changes will, and future railroad 
changes that are currently unknown could, have a significant impact on 
the Board's cost-of-capital determination, the Board finds that now is 
an appropriate time to consider the addition of a model that could 
improve its methodology for estimating the cost-of-equity component of 
the cost of capital.
---------------------------------------------------------------------------

    \11\ For example, significant operating changes like precision 
scheduled railroading are not like the enactment of the Tax Cuts and 
Jobs Act, Public Law 115-97, 131 Stat. 2054 (2017), which was a one-
time occurrence that merited a one-time adjustment to the cost of 
capital. See R.R. Revenue Adequacy--2017 Determination, EP 552 (Sub-
No. 22) et al., slip op. at 1-3 (STB served Dec. 6, 2018).
---------------------------------------------------------------------------

    As described in more detail below, the Board finds that the 
addition of Step MSDCF, when used in combination with the current 
Morningstar/Ibbotson MSDCF and CAPM, could enhance the robustness of 
the resulting cost-of-equity estimate during periods, like the present 
one, in which certain railroads are undertaking significant operating 
changes. Furthermore, consistent with the Board's previous finding, 
supported by extensive economic literature, that averaging multiple 
models--based on different perspectives, relying on different inputs, 
and with different strengths and weaknesses--would produce estimates 
that are more robust when averaged together,\12\ the addition of Step 
MSDCF would improve the cost-of-capital determination, including during 
periods of significant operating changes.
---------------------------------------------------------------------------

    \12\ See Pet. of the W. Coal Traffic League, EP 664 (Sub-No. 2), 
slip op. at 11 (STB served Oct. 31, 2016).
---------------------------------------------------------------------------

    Like Morningstar/Ibbotson MSDCF, Step MSDCF proposed here would 
continue to calculate growth of earnings in three stages. The first and 
third stages would be identical to those of Morningstar/Ibbotson MSDCF. 
In the first stage (years one through five), the qualifying railroad's 
annual earnings growth rate would be the median value of its three- to 
five-year growth rate estimates and, in the third stage (years 11 and 
onwards), the growth rate would be the long-run nominal growth rate of 
the U.S. economy. The growth rate of the second stage (years six 
through 10) would be a gradual transition between the first and third 
stages. The transition would begin at year six and step down or up in 
equal increments each year towards the terminal growth rate (or third 
stage). The algebraic formula for Step MSDCF is described in full in 
Appendix A.
    The Board proposes to add Step MSDCF to its cost-of-capital 
methodology based in part on input from commenters in prior 
proceedings. Since the Board's adoption of its current hybrid 
methodology in 2009, Western Coal Traffic League (WCTL) has opposed the 
Board's use of Morningstar/Ibbotson MSDCF in its cost-of-equity 
calculation. One of WCTL's primary criticisms has been that using the 
average of all of the qualifying railroads' median growth rates in 
stage one as the growth rate in stage two is unreasonable because 
three- to five-year forecasts of earnings growth will not likely be 
accurate for ten years. See Use of a Multi-Stage Discounted Cash Flow 
Model, EP 664 (Sub-No. 1), slip op. at 8-9. Additionally, WCTL has 
argued that Morningstar/Ibbotson MSDCF lacks a transition mechanism, 
which prevents smooth transitions between stages. See Pet. of the W. 
Coal Traffic League, EP 664 (Sub-No. 2), slip op. at 9 (STB served Oct. 
31, 2016).
    In affirming the reasonableness of Morningstar/Ibbotson MSDCF's 
second-stage growth rate, the Board has noted that (1) the returns of 
individual firms should revert to the industry average over time, (2) 
it is not realistic to predict growth for individual companies beyond 
five years, and (3) attempting to create smoother transitions between 
the stages would add more complexity to the model but would not 
guarantee more precision, in part, because the cost of equity cannot 
ever be truly known. See Pet. of the W. Coal Traffic League, EP 664 
(Sub-No. 2), slip op. at 13 (STB served Oct. 31, 2016). The Board 
continues to believe that Morningstar/Ibbotson MSDCF is reasonable. At 
the same time, there are other reasonable models based on different 
perspectives, relying on different inputs, and with different strengths 
and weaknesses. Forecasting growth rates in years six through 10 is 
inherently imprecise, and it is not possible to predict whether one 
model will better reflect future events, particularly when those events 
must be judged over decades of differing market characteristics. The 
Board's proposal to incorporate another model to improve the robustness 
of its overall cost-of-equity estimate implies neither that the Board 
expects to achieve perfect precision across models nor that the Board's 
existing models are inadequate. The Board finds it is reasonable to 
continue to rely on Morningstar/Ibbotson MSDCF as one aspect of its 
cost-of-capital methodology.
    Even so, the Board recognizes that the significant operating 
changes undertaken by certain individual railroads have given those 
railroads a significant increase in growth rates that flows through to 
the second stage of Morningstar/Ibbotson MSDCF, and it is always 
possible that future railroad changes could have a similar effect. 
Specifically, because the second-stage growth rate in Morningstar/
Ibbotson MSDCF uses the simple average of all qualifying railroads' 
three- to five-year median growth rate estimates from the first stage, 
the growth rates in the middle horizon (years six through 10) will be 
similar to the averages of growth rates in the short term (three- to 
five-year estimates). By drawing upon the three- to five-year growth 
rate estimates twice, Morningstar/Ibbotson MSDCF is more sensitive to 
growth rate changes in the short term, which may involve anomalous 
increases or decreases, relative to a model with a gradual transition 
between the first and third stages. While reasonable, Morningstar/
Ibbotson MSDCF may not capture information relevant to the middle 
horizon in the same way as other models.\13\ Therefore, the Board's 
cost-of-equity estimate could yet be made more robust by adding a 
model, like Step MSDCF, that reflects a different perspective for the 
middle horizon.\14\
---------------------------------------------------------------------------

    \13\ The Board has repeatedly rejected WCTL's argument that 
Morningstar/Ibbotson MSDCF should be abandoned due to what WCTL 
argues is its flawed second-stage growth rate, but the Board has not 
previously considered how a MSDCF variation with a different second-
stage growth rate could supplement Morningstar/Ibbotson MSDCF. The 
Board proposes that Step MSDCF could be useful as a supplement, 
rather than a replacement, for Morningstar/Ibbotson MSDCF because, 
while Step MSDCF adds a different perspective with respect to growth 
rates, Step MSDCF may not necessarily be more reasonable than 
Morningstar/Ibbotson MSDCF in certain periods or over the long term.
    \14\ In comments submitted for the 2018 cost-of-capital 
proceeding, AAR stated that Morningstar/Ibbotson MSDCF ``assumes 
`that over a middle horizon, growth of any particular company will 
lie more in line with the industry as a whole,'' which means that 
``other companies `catch' their industry growth leaders, or the 
leaders fall back to the rate of the slower growth railroads.'' 
Accordingly, AAR argued that ``[a]ny attempt to change the second 
stage to a transition stage is corrupting the intent of the model.'' 
AAR Comments, V.S. John Gray 45, Apr. 22, 2019, R.R. Cost of 
Capital--2018, EP 558 (Sub-No. 22). The Board does not propose to 
modify Morningstar/Ibbotson MSDCF in this decision. Instead, the 
Board proposes to add a new model that relies on different 
assumptions to be used alongside Morningstar/Ibbotson MSDCF. This 
approach allows the Board to introduce a model that will have a 
moderating influence on Morningstar/Ibbotson MSDCF while also 
maintaining the integrity of Morningstar/Ibbotson MSDCF.
---------------------------------------------------------------------------

    The Board proposes to retain the same CAPM that it has used to 
calculate the cost of capital since 2008. See Methodology to be 
Employed in Determining the R.R. Indus.'s Cost of Capital, EP 664, slip 
op. at 2. The Board's current methods for determining the railroad 
industry's beta and estimating market-risk premium are reasonable. 
Furthermore, recent

[[Page 55900]]

operating changes have not demonstrated similar issues in the cost-of-
equity estimates produced by CAPM as they have for Morningstar/Ibbotson 
MSDCF. Accordingly, the Board proposes that to reduce the impact of 
short-term operating changes on the cost of capital, it is not 
necessary for the Board to modify CAPM.
    CAPM, generally, is a backward-looking model while MSDCF is more 
forward-looking, each looking at different market data. R.R. Cost of 
Capital--2018, EP 558 (Sub-No. 22), slip op. at 3. To maintain an equal 
balance between forward-looking and backward-looking models, the Board 
proposes to use a weighted average of the three models in its cost-of-
equity calculation, with CAPM weighted at 50%, Morningstar/Ibbotson 
MSDCF weighted at 25%, and Step MSDCF weighted at 25%. Furthermore, 
because the Board has not found that MSDCF is superior to CAPM, or vice 
versa, it is reasonable to use a weighted average of the three models 
that allows both model types to continue to contribute equally to the 
cost of equity.
    When applied over a 10-year historical analysis period, the 
weighted average of the three models results in a lower variance than a 
forecast relying on the average of CAPM and Morningstar/Ibbotson MSDCF 
alone. For the period 2009 through 2018, the average of CAPM and 
Morningstar/Ibbotson MSDCF produces a cost of equity ranging from 
10.31% to 13.86% with a standard deviation of 1.18. Over the same 
period, the weighted average of the three models produces estimates 
between 10.25% and 13.45% with a standard deviation of 1.09. See 
Appendix B.
    Adding Step MSDCF to the Board's current methodology for 
calculating the cost of capital is consistent with the Rail 
Transportation Policy. 49 U.S.C. 10101. For instance, having a 
methodology that more robustly estimates the cost-of-equity component 
of the cost of capital would better ensure that rail carriers are 
allowed to earn adequate revenues. section 10101(3); see also Standards 
for R.R. Revenue Adequacy, 364 I.C.C. 803, 811 (1981), aff'd sub nom. 
Bessemer & Lake Erie R.R. v. ICC, 691 F.2d 1104 (3d Cir. 1982) 
(concluding that ``the only revenue adequacy standard consistent with 
the requirements of [The Staggers Rail Act of 1980] is one that uses a 
rate of return equal to the cost of capital''). As noted, Morningstar/
Ibbotson MSDCF is more sensitive to growth rate changes in the short 
term relative to Step MSDCF, and Step MSDCF may be better suited for 
some periods, or even over the long run.
    Interested parties are invited to comment on the proposed use of 
Step MSDCF described above in conjunction with CAPM and Morningstar/
Ibbotson MSDCF currently used by the Board. Parties are encouraged to 
address issues such as the most appropriate way to integrate the three 
models into the cost-of-capital calculation, including the particular 
weighting that each model should have.

Regulatory Flexibility Act

    The Regulatory Flexibility Act of 1980 (RFA), 5 U.S.C. 601-612, 
generally requires a description and analysis of new rules that would 
have a significant economic impact on a substantial number of small 
entities. In drafting a rule, an agency is required to: (1) Assess the 
effect that its regulation will have on small entities, (2) analyze 
effective alternatives that may minimize a regulation's impact, and (3) 
make the analysis available for public comment. Section 601-604. In its 
notice of proposed rulemaking, the agency must either include an 
initial regulatory flexibility analysis, section 603(a), or certify 
that the proposed rule would not have a ``significant impact on a 
substantial number of small entities,'' section 605(b). Because the 
goal of the RFA is to reduce the cost to small entities of complying 
with federal regulations, the RFA requires an agency to perform a 
regulatory flexibility analysis of small entity impacts only when a 
rule directly regulates those entities. In other words, the impact must 
be a direct impact on small entities ``whose conduct is circumscribed 
or mandated'' by the proposed rule. White Eagle Coop. v. Conner, 553 
F.3d 467, 480 (7th Cir. 2009).
    The Board certifies under 5 U.S.C. 605(b) that this rule would not 
have a significant economic impact on a substantial number of small 
entities as defined by the RFA. Cost of capital is calculated for those 
Class I carriers that meet certain criteria developed in Railroad Cost 
of Capital--1984, 1 I.C.C.2d 989 (1985), and modified in Revisions to 
the Cost-of-Capital Composite Railroad Criteria, EP 664 (Sub-No. 3) 
(STB served Oct. 25, 2017). Therefore, the Board's proposed methodology 
will apply only to Class I rail carriers, and there will be no impact 
on small railroads. A copy of this decision will be served upon the 
Chief Counsel for Advocacy, Office of Advocacy, U.S. Small Business 
Administration, Washington, DC 20416.
    Additional information supporting the Board's revised proposal is 
contained in the Board's decision (including appendices) served on 
October 11, 2019. To obtain a copy of this decision, visit the Board's 
website at http://www.stb.gov.
    It is ordered:
    1. The Board proposes to revise its methodology for determining the 
railroad industry's cost of capital as set forth in this decision. 
Notice of this decision will be published in the Federal Register.
    2. Comments are due by November 5, 2019. Reply comments are due by 
December 4, 2019.
    3. A copy of this decision will be served upon the Chief Counsel 
for Advocacy, Office of Advocacy, U.S. Small Business Administration.
    4. This decision is effective on its service date.

    Decided: October 11, 2019.

    By the Board, Board Member Begeman, Fuchs, and Oberman.
Kenyatta Clay,
Clearance Clerk.
[FR Doc. 2019-22748 Filed 10-17-19; 8:45 am]
BILLING CODE 4915-01-P