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Information > Financial Terms > This page Fair Return Used principally
in connection with earnings of railroad and public utility corporations.
It developed out of the notion that such public service corporations,
by serving the public interest and in many cases being granted monopolistic
franchises, should be allowed to charge only such rates for their services
as would yield a reasonable return on the fair value of the assets devoted
to providing the service. A
fair return, therefore, involves two variables:
(1) fair valuation of the property required for the services, and
(2) fair rate of return thereon. For
years, the 1898 case of Smyth
v. Ames (169 U.S. 466) was the leading case in valuation cases involving the
necessary elements in fair value.
The comprehensive role of that case read as follows:
"And in order to ascertain that value, the original cost of construction,
the amount expended in permanent improvements, the amount and market value
of its bonds and stocks, the present as compared with the original cost
of construction, the probable earning capacity of the property under particular
rates prescribed by statute, and the sum required to meet operating expenses,
are all matters for consideration, and are to be given such weight as
may be just and right in each case.
We do not say that there may not be other matters to be regarded
in estimating the value of the property." Both
the original cost and reproduction cost bases for fair valuation were
recognized in the above, as well as capitalization and market value thereof.
The Supreme Court, however, did not indicate the basis to be used,
or even combination of bases, and as a result the courts became involved
in a series of valuation cases over the years.
By 1933, the Supreme Court was ready to leave the determination
of fair valuation and fair rates to the administrative agency concerned,
"so long as constitutional limitations are not transgressed"
(Los
Angeles Gas & Electric Corp. v.
Railroad
Commission of California, 289 U.S. 287).
Emphasis on any single formula or combination of formulas was finally
abandoned in the landmark case of Federal
Power Commission v.
Hope Natural Gas Co., 320 U.S. 591 (1944), in which the doctrine of end
result was enunciated, as follows:
"Under the statutory standard of "just and reasonable" it is the
result reached not the impact of the rate order which counts.
If the total effect of the rate order cannot be said to be unjust
and unreasonable, judicial inquiry under the Act is at an end.
The fact that the method employed to reach that result may contain
infirmities is not them important." Thus
emphasis has shifted from the valuation formula to the earnings result
of rates allowed.
The Hope case indicated that fair rates would be those
"which enable the company to operate successfully, to maintain its financial
integrity, to attract capital, and to compensate its investors for the
risks assumed …"
At the federal level, the Federal Power Commission used to standardize
rates of return as 6% for all electric companies and 6.5% for all natural
gas companies under its jurisdiction, but in recent years it has abandoned
such generalization and passes on rates on an individual basis.
The Federal Communications Commission prescribes just and reasonable
rates for interstate of foreign communications companies.
State regulatory commissions operate under varying statutory conditions,
some states providing no rate regulatory powers at all over specified
types of utilities. |